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Motorola Valuation Analysis
Valued as of April 1, 2007
Analysts:
Christy Alanis: [email protected]
Sara Kutscher: [email protected]
Lesley Radicke: [email protected]
Lauren Slater: [email protected]
Zach Tubb: [email protected]
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Table of Contents:
Executive Summary………………………………………….. 3
Company and Industry Analysis ………………………..... 8
Accounting Analysis ………………………………………... 20
Ratio Analysis and Forecasted Financials ……………... 37
Valuation Analysis …………………………………………… 66
Appendix 1- Screening Ratios ……………………………. 77
Appendix 2- Financial Ratios ……………………………… 78
Appendix 3- Forecasted Financials ……………………… 79
Appendix 4- Valuation Models ……………………………. 81
Appendix 5- Cost of Debt …………………………………… 85
Appendix 6- Regression …………………………………….. 86
References ……………………………………………………... 94
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Executive Summary
Investment Recommendation: Overvalued, Sell 04//1/07
MOT – NYSE $17.57 EPS Forecast 52 week range $17.33 - $26.30 FYE 2006(A) 2007(E) 2008(E) 2009(E) Revenue (2006) $42,879,000 EPS $1.46 $1.65 $1.77 $1.90 Market Capitalization $42.00 Bil
Shares Outstanding 2.39 Bil Ratio Comparison MOT NOK ERIC Dividend Yield 1.10% Trailing P/E $23.51 $21.09 $26.57 3-mth Avg. Daily Trading Volume 32,798,600 Forward P/E $23.37 $20.97 $26.42 Percent Institutional Ownership 74.10% M/B $23.55 $16.24 $42.78 Book Value Per Share (mrq) $6.164
ROE 15.22% Valuation Estimates ROA 5.54% Actual Price (04/01/07) $17.57 Est. 5 year EPS Growth Rate N/A Ratio Based Valuation
Cost of Capital Est. R2 Beta Ke Trailing P/E $15.47 Ke Estimated 11.3 Forward P/E $19.97 3-month .133 1.01 11.3% M/B $2.90 1-year .132 1.00 11.3% 5-year .130 .99 11.2% Intrinsic Valuations Estimated
7-year .130 .99 11.2%
10-year .129 .99 11.2% Discounted Dividends $1.25 Published 1.35 Free Cash Flow $35.62 Kd MOT: Residual Income $8.72 WACC MOT: Abnormal Earnings Growth $12.90
Altman Z-score: MOT: 3.87
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Recommendation: Overvalued Firm
Company and Industry Overview, and Analysis
Motorola is the second largest manufacturer of headsets in the
telecommunications industry, second only to Nokia. Motorola operates under the idea of
“seamless mobility” that was developed in 2004. This idea is centered on wirelessly
connecting the world through their customer’s mobile devices, homes, and businesses.
Motorola has received several awards in recent years for their advances in technology
and continuous customer service. Motorola has facilities located all over the world from
the United States to India to China. They provide products for large companies such as
Comcast and Sprint Nextel. Motorola is a company that continues to improve on the
technologies of today to improve the future of tomorrow’s world.
The telecommunication industry as a whole is competitive and as the demand for
high tech products increases, the industry continues to grow as well. The major players
in the telecommunication industry are Nokia, Motorola, Ericsson, LG, and Samsung. The
entire industry is composed of 2000 companies with combined revenue of over $65
billion dollars, with the largest of companies holding 75% of the total market. The
industry as a whole is hard to enter and hard to leave because the industry requires
highly specialized products and requires high amounts of manufacturing facilities. It is
best for a company to be one of the first in this industry because it can help set
standards. Many companies within the industry lease out their facilities which includes
office space, equipment, and land. In order to survive in the industry, Motorola along
with the other companies must sell mass amounts of their products before the products
become obsolete. In the telecommunications industry, customers have a high
bargaining power because of the low switching costs. Switching costs among suppliers
is also low because suppliers can produce mass quantities of products at a low cost.
Accounting Analysis
Motorola releases a 10-K after every fiscal year. This 10-K is a document that
contains all financial information about a company that is used to value them. It is also
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helpful for investors in determining if they would want to invest in the company or not.
Motorola’s 10-K disclosure was poor and we were unable to find rates and terms
needed for further analysis.
The main problems in the 10-K were that we were unable to find the discount
rate and the length of the leases, making investors unsure of their actual lease
obligation values. Despite these faults in their 10-K Motorola did a good job of
disclosing information about their different segments. The management discussion was
efficient in explaining the business and their goals. The only red flag that was found
with Motorola was the missing lease terms and discount rate, making it difficult to
accurately determine lease values. With an assumed discount rate, it was found that if
Motorola capitalized their leases instead of considering them to be current operating
leases, there would room for concern; we therefore believe that they are not hiding
liabilities behind their leases.
Motorola has 3 main key accounting policies which include research and
development, customer service, and goodwill. Since the company is defined as
competing on differentiation these key accounting policies are factors that take
Motorola above the competitors which is why there is so much money and time put into
them. Another factor to consider in the accounting analysis is Motorola’s flexibility.
They specifically utilize their flexibility to promote their most important assets as a
company. Research and development is one aspect Motorola attempts to keep flexible
because it is important for the development of the company, and managers have no
accounting discretion over it. Another factor of their flexibility is the deprecation
method of straight-line, declining balance, and inventory method of FIFO. In Motorola’s
accounting analysis, the company is defined as aggressive in the fact that they are FIFO
inventory based. Also, Motorola reserves $501 million for their warranties, which goes
hand in hand with the customer service key accounting policy. Motorola acquired a lot
of goodwill in the five year analysis, leading us to believe that they are aggressive since
it increases their assets and gives them more room to grow.
Screening ratios were run to see if Motorola was hiding expenses or overstating
their revenue. By overstating revenue or understating expenses, Motorola would be
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boosting their net income, operating income, and their retained earnings. It would
cause investors to make decisions with incorrect information. Although Motorola’s 10K
is audited, a company can still provide false information. Unless Motorola properly
states why certain ratios jumped or dropped, it is a red flag for analysts. Overall,
Motorola does not overstate or understate their revenue or expenses.
Financial Ratio Analysis
When analyzing financial ratios for a company, they are divided into three
divisions: liquidity, profitability, and capital structure ratios. All of these ratios are very
helpful when it comes to comparing the company in different areas to its competitors.
The liquidity ratios contain seven ratios that are used to relate how well a firm can
maintain its cash resources to cover its current obligations. These ratios also tell how
strong the cash to cash cycle is by using inventory turnover, days of supply in
inventory, accounts receivable turnover, and days until collection of accounts
receivable. Profitability ratios look at a company from another prospective. A
company’s operating efficiency, asset productivity, and rate of return on assets and
equity is explained by using profitability ratios. If these ratios are calculated correctly,
they can give information about how profitable the company has been in prior years
through information from the balance sheet and income statement. Capital structure
ratios deal with how the company is financed. The first capital structure ratio that is
calculated is the debt-to-equity ratio, to see if the company generates enough assets to
pay back its interest and debt obligations.
For a telecommunications company, forecasting of financial statements is very
important. Forecasted financials give managers an idea of where the company is going,
where it needs to improve, and sets goals. By analyzing how well Motorola did in the
previous five years, forecasting for the next ten years was possible. Since every year is
different, a smooth growth rate was used for all aspects of the income statement,
balance sheet, and statement of cash flows.
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Intrinsic Valuation
There are four key models to run when valuing a company. These models
include the dividends discounted, free cash flows, residual income, and abnormal
earnings growth. In each model, the cost of capital or the weighted average cost of
capital (WACC) was used to compute the intrinsic value per share for Motorola. The
cost of capital was found after running a regression of the market risk premium and the
risk free rate of return. The WACC was found by inputting the cost of debt and cost of
capital into the CAPM model.
The dividend discount model yielded a $1.25 per share using the cost of capital.
This model has a low degree of explanatory power for the stock price in general. The
free cash flow model yielded a $35.62 per share value using the WACC, while the
residual income returned a value of $8.72 per share using the cost of capital. The
residual income model has the highest degree of explanatory power because it takes
into account more of the firm’s variables, such as, beginning book value of equity, net
income, and return on equity. The AEG model was run last using the cost of capital and
returned a value of $12.90 per share. After finding intrinsic values per share from each
model, the ratios were compared to the stock price of Motorola at April 1, 2007.
Lastly, an Altman’s Z-score was found for Motorola. Banks use this number when
firms try to take out Loans. The number is used to determine the risk of a firm, or in
other words, to see how likely the firm is going to go bankrupt. The higher this number
is, the more stable it is and the less likely it is going to file for bankruptcy.
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Company and Industry Overview
Overview:
Motorola was established in 1928 under the laws of the State of Delaware and
has its corporate offices located in Illinois. It also has development centers within the
United States in Texas, Illinois, Florida, and Arizona, as well as in Germany, Argentina,
China, South Korea, and Russia, to name a few. The company is a leading, global
manufacturer in telecommunication products ranging from two way radios to electronics
within vehicles to emergency equipment. Motorola operates on the idea of “seamless
mobility” (Motorola.com). Its vision is that the newest technologies better connect their
customers with satisfaction and style. This company is ranked 54 in the Fortune 500
and 108 in the FT Global 500 (hoovers.com).
In 2004, Edward Zander was named Chairman and CEO of the company. His
vision was to help turn Motorola around and back into the profitable company it once
was. Since that time, Motorola has received the National Medal of Technology, the
“United States’ highest honor for technological innovation” (Motorola.com). Then, in
2007, the company received the Best Corporate Citizen Award and was ranked fourth in
America’s 100 Best Corporate Citizens (Motorola.com).
Motorola is the number two manufacturer of wireless headsets in the world
behind Nokia (hoovers.com). This company is composed of four segments: mobile
devices, government and enterprise solutions, networks, and connected home solutions
(Motorola 10K 2005). The company grew substantially in 2005 due to the 40% increase
in the sales of the company’s leading product, the RAZR. Motorola developed the SLVR
and the Q, the cousins to the RAZR, to keep the sales increasing. Also, Motorola has
partnered with Apple and Kodak to increase the features on their mobile devices and to
increase its overall sales.
2001 2002 2003 2004 2005
Sales 26,568 23,422 23,155 31,323 36,843
Assets 33,398 31,233 26,809 30,922 35,649
• in millions
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The Motorola products have evolved over the years. In 2000, Motorola teamed
up with to Cisco to come out with the first GPRS cellular system, which is a radio
package service in the United Kingdom (Motorola.com). In 2003, Motorola was the first
to put the lunix and java technology into their cell phone along with full PDA
functionality (Motorola.com). To further enhance the cellular devices, Motorola
developed the RAZR in 2005 with internet and photography capabilities accompanied
with Bluetooth® technology. Also in 2005, Motorola combined licensed broadband and
unlicensed Wi-Fi radios into a single point to provide better efficiency for public safety
agencies. In the past year, Motorola unveiled the Motorola MING smart phone in the
Asian market. This phone can recognize over 10,000 Chinese symbols (Motorola.com).
Motorola has a market capitalization of 42 billion as of April 2007 with over 2.4
billion shares outstanding (finance.yahoo.com). Recently, Motorola’s stock lost 19% of
its value in 2006 due to “underperforming business, an inefficient balance sheet, and
management under the gun.” (hoovers.com) Motorola’s loss was Nokia’s gain and
decreased Motorola’s profit margin by 7.2% in one year. In January 2007, Carl Icahn
tried to attain a seat on Motorola’s board of directors by buying $2.3 billion in Motorola
shares (wikipedia.com).
Sprint Nextel is Motorola’s largest customer, accounting for the majority of its
mobile devices segment sales and for more than 25% of the network segment sales.
Comcast is the largest customer for Motorola’s connected home solutions segment by
accounting for 31% of this segment’s net sales. Needless to say, that any disruption
between Sprint Nextel and Comcast would cause serious consequences to Motorola’s
business.
Nokia is Motorola’s largest competitor with 34% of the market. Samsung and LG
fall behind Motorola with 12.8% and 6.9%, respectively. Ericsson falls at the end with
5.9% of the telecommunications market. Two years ago, Motorola faced the threat of
being bought out by Samsung and was forced to create a new product to stay within
the top five. Motorola developed and sold 50 million RAZR phones that incorporated the
newest technology and sleekest design.
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Five Forces Model:
The telecommunications industry consists of several firms that define new
century technology. Motorola is among many giants that strive for success in a
competitive environment. It has proven its strength in market development, trade
shows, domestic and international advocacy, and standard developments that have
enabled e-business. The five forces model for the telecommunications industry outlines
the environment that Motorola intends to dominate in the near future.
Rivalry Among Existing Firms
Industry growth
At the beginning of the late 1990’s the telecommunication industry
experienced substantial growth. The industry experienced a $1.2 trillion growth at the
end of 2006 and is foreseen to have “continued strong growth in wireless
communications,” (www.send2press.com). The company is expected to grow at a rate
of 11.6 percent from previous years' sales, according to the Telecommunication
Industry Association. The high demand for high tech products and services continues
to steadily increase. Motorola will therefore experience growth and have a strong
competitive advantage in selling mobile devices. Such devices include the MOTOKRZR
and the MOTORIZR Z3.
Concentration
Concentration refers to the size of a company in a specific industry, as well as its
pull in determining pricing, as well as competitive moves. The telecommunication
industry is comprised of about 2000 companies with combined annual revenue of $65
billion. The industry is highly concentrated with the largest companies holding 75% of
the total market. For example, Motorola, Nokia, and Ericsson are the top three leading
telecommunication companies in the telecommunication industry. Motorola has to
therefore compete on a competitive innovative level. Customers will only purchase
products and services produced with the most recent technology. In order to gain
market loyalty, Motorola has provided customers with 24 hour support services, as well
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as repair or replacement services for damaged products. Nokia has become a strong
competitor, producing similar products and services such as the Nokia E62, and
Bluetooth capable devices. We therefore have come to the conclusion that the
industry’s concentration is relatively high.
Differentiation and Switching Costs
Differentiation is important to consider when analyzing the telecommunication
industry. Differentiation refers to the degree in which a company provides
differentiated products and services. If a company’s products and services are similar
to others’ in the same industry, then customers have an incentive switch to another
company solely based on price. Motorola, for example states that they create
differentiation through, “compelling and rich experiences”, what they call the “mobile
me” campaign (www.motorola.com). Switching costs are however low for customers
who are provided with several products through intermediaries. Such intermediaries,
such as Sprint Nextel, may carry up to six different brands in their store.
Fixed- Variable Costs
Many companies in the telecommunications industry lease out facilities, office
spaces, factory and warehouse space, land, and other equipment under non-cancelable
agreements. Motorola leased out 295 facilities in 2004, which has since increased.
Rental expenses are considered a variable expanse, an expanse that many
telecommunication companies have due to numerous large facilities. It is important to
note that in order to survive, Motorola, as well as its competitors, must sell a vast
amount of its products before the products become obsolete. Motorola is a leader
when it comes to turning over its inventory before introducing new products to the
market. The company’s inventory turned at 8.9 percent in 2004 compared to 7.6
percent in 2003, and has continually stayed competitive in this area.
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Exit Barriers and Excess Capacity
There continues to be a high demand for products and services in the
telecommunication industry. In Motorola’s 2005 10-k, they state that the company has
increased its demand for its products by 25% due to new innovations. Therefore, there
seems to be little incentive for companies to cut prices in order to fill capacity. It is then
reasonable to assume that since the telecommunications industry focuses on producing
specialized products, the exit barriers are high, punishing companies that may choose
to leave the industry.
Threats of New Entrants
Economies of Scale
Economies of scale refer to companies facing the dilemma of whether to invest in
a large capacity that may not be utilized right away, or have less than desired capacity.
The telecommunication industry requires large investments be made toward physical
plant and equipment. This therefore makes it difficult for new entrants to compete with
Motorola or Nokia. Brand name recognition is also a hard characteristic to compete
against. Known brands often prevent new companies from starting off ahead. The
telecommunication industry also provides services, such as establishing land lines,
which in turn allows new entrants to create a competitive pricing framework. After
such analysis, the industry’s economy of scale is considered to be at a moderate to high
level.
First Mover Advantage
First mover advantage is often the first in the industry that has the ability to set
standards for new entrants. According to Motorola, component parts are kept in stock
for products that are no longer produced in order to satisfy customer needs. Certain
licenses have also been granted in order to maintain operation at a maximum capacity.
It is also important to consider that many of Motorola’s products are distributed through
retailers. The relationship that the industry has created with retailers such as Sprint
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Nextel, has further allowed for the ease of distribution. Such examples allude to the
idea that companies such as Motorola have a first mover advantage.
Access to Channels of Distribution and Relationships
The access channels of distribution refer to the developed relationships between
preexisting companies in the industry and suppliers or buyers. New entrants often have
a hard time entering into an industry due to these relationships. In an industry that
consists of high tech products and services, it is essential to have strong relationships
with both suppliers and buyers. For instance, Motorola has contracts with electronic
manufacturing suppliers to lower costs and meet customer demands. Also many of the
top telecommunication industries hold strong ties to buyers, such as Sprint Nextel, that
provided customers with a variety of Motorola, Nokia, and Ericsson products.
Legal Barriers
Legal barriers are for example patents, contracts, and copyrights that give
existing companies an advantage over novice. These industry barriers are seen as
obstacles to new entrants and are often granted to companies that have created and
sustained relationships with other major industry factors. Patents or legal barriers
allocate rights to Motorola that potential entrants cannot receive so easily. In the
telecommunications industry, such barriers have a strong effect of the entrance of
interested companies. During 2005, Motorola was granted 548 utility and designed
patents in the U.S. alone.
Threat Substitutes Products
Telecommunication companies compete to maintain a spot in a highly
competitive technological arena. Relative to Motorola’s leading position in the
telecommunication’s industry, several companies have achieved similar product design
and innovation. Among such companies is for instance, Nokia. A company such as
Nokia provides a wide variety of technological devices and similar services. Therefore,
competition arises based on available services. In order for Motorola to maintain its
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position it must provide a variety of services that entice customers. For example, on
Motorola’s website, (Motorola.com), customers can find an easy to navigate support
system that can help quickly solve a wide range of problems concerning cordless
phones, home monitoring, and digital audio players among many others. Buyers’
willingness to switch to a different product brand is relatively high and is not only based
on the most novel products available, but also on service.
Bargaining Power of Buyers
Retailers, such as Sprint Nextel, provide consumers with a large selection of
products from which to choose from. The relative bargaining power that customers
carry in the telecommunication industry is ultimately strong because of significantly low
switching costs. Product cost and quality are also evidently important characteristics to
customers. Although costly, the quality that Motorola has provided has won the
approval of several critics, receiving awards for its consistent improvements. Within the
last year the telecommunications industry has provided thousands of different products
and services to millions of customers around the world.
Bargaining Power of Suppliers
Several suppliers contribute to the telecommunications industry.
Imported component parts create the products and systems that the companies in the
telecommunications industry produce. Differentiation, as well as switching costs among
suppliers is low due to mass productions of component parts that it contributes to the
telecommunications industry. Numerous suppliers send products in bulk to companies
like Motorola and Nokia, among others, to create innovative product lines for the public.
Due to the long-term relationships established between suppliers and
telecommunication companies, suppliers have a strong pull with the companies.
Value Chain Analysis:
In the mobile communications industry companies are constantly trying to
differentiate themselves. Companies such as Nokia, Motorola, and Ericsson are all
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coming out with Innovative products, which keep raising the bar. For each to
differentiate itself, the industry must have some key success factors to have a
completive advantage.
Superior Product Quality
One key success factor of the industry is superior product quality. The
telecommunications industry must create products that last and not wear out during
normal use. To differentiate oneself from the rest of the industry, products need to
have quality at both ends, from supplies to the craftsmanship of the product. Without a
quality product things will wear out faster and cause customers to associate low quality
with your brand, and people tend to talk more about negative things than positive.
Superior Product Variety
The industry also must develop a variety of quality products with a relatively low
price. The industry must produce a variety of products that will form to the needs of
different customers. For example, Nokia and Motorola have developed wireless mobility
products that allow networks to customize their packages. To illustration, a customer
can have internet access as well as PDA functionality on their telephones. This is a key
success factory that differentiates them within the industry, and will allow customers to
choose which product is right for them.
Superior Customer Service
In addition to having a plethora of different products, the industry must exert to
above average customer service. For example, customers will be unwilling to buy a
company’s products if they can never get a hold of a customer service representative.
This is a big key success factor, and without superior customer service companies will
find it hard to excel in today telecommunications industry.
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More Flexible Delivery
Companies in the market must embody flexibility while delivering products to
consumers. If a company takes too long delivering a product, or if a consumer can only
get it during allotted hours, the company will be doomed to failure. Companies need to
have their delivery systems set up so that it arrives quickly and to almost anywhere.
That is why flexible delivery is a key success factor in differentiating yourself from the
industry.
Investment in Brand Image
One key success factor that helps companies differentiate themselves in this
industry is brand image. Companies need to let consumers know about their products
and what new innovations they have through extensive advertising. In 2005, Nokia
spent 1.25 million on advertising and their net sales in 2005 were substantially higher
than Motorola and Ericsson’s sales. This helps establish your brand and makes people
pay a price premium for your product.
Investment in Research and Development
To be a good competitor in this industry, companies need to invest a significant
amount of time and effort into research and development. That is why R&D is another
huge key success factor in the telecommunications industry. The following graph
indicates how much capital the industry spends annually, specifically over the past three
years.
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Research and Development Expeditures
0
1000
2000
3000
4000
5000
6000
2005 2004 2003
in m
illio
ns o
f dol
lars
MOTNokiaEricsson
In the graph above shows that Motorola spent an average of 11.26% of their
sales on research and development. Nokia spent an average of 12.3%of their sales on
R&D, and Ericsson spent an average of 17.93% of their sales on R&D. Ericsson is trying
to compete with the other two industry leaders that is why they are putting so much
into R&D.
All of these are key success factors of the industry. If a company does not
perform well in these certain areas, then it will need to make adjustments and try
harder. These factors will help a company gain competitive advantage and profits over
the industry.
Competitive Advantage:
The Motorola Corp. is broken up into four segments which include: the mobile
devices, Government and Enterprise Solutions, Networks, and Connected Home
Solutions. Each segment entails specific characteristics that categorize them as
competing on differentiation. In the mobile device segment, Motorola competes on
differentiating itself from the industry standard with key success factors. They do this
by providing superior products with a variety of options. For example, Motorola offers
mobile devices that can gain access instantaneously to the internet, to devices with
cameras, or devices that play music, all at a price within the consumer’s budget.
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In the government and enterprise solutions segment, Motorola has developed
seamless mobility, which is connecting all parts of digital components. “Our car, our
mobile phone, our home security system, our office, all the systems
that surrounds us, will communicate with each other automatically to fill
our environment with our preferences, our desires, our music collections, everything we
need or want to feel connected anywhere, anytime” (Motorola 10-k 2005). In
government and enterprise solutions segment, Motorola engages in a high a variety of
high quality products backed by extensive R&D.
Motorola’s third segment: connected home solutions, bases its key success
factors on quality and delivery. A focus on relationships with communication operators,
as well as cable television equipment, allows Motorola to excel in the technological
world. New product development is a consistent goal for Motorola, attempting to
differentiate in digital set-top boxes, as well as staying involved in the growing HD and
DVR markets. A development of digital video products compliant with a region’s
requirements is a step that Motorola has recently taken to reach larger markets.
However, they are really trying to set themselves apart by focusing on providing
networks with broadband wireless internet. Motorola introduced its MotoWi4 Canopy
product, which has provided customers with the capability of a having innovative low
cost internet access (Motorola.com). Motorola is developing fixed and mobile
broadband standards, which allows them to provide superior customer service and
product quality. Competing so aggressive in every segment of the telecommunications
industry, Motorola attempts to maintain a competitive advantage. Motorola
differentiates itself from its competitors through key success factors like: superior
customer service, wide product variety, and high investment in research and
development.
Motorola created their “Seamless Mobility” campaign in 2004 and continues to
use this idea in their daily operations (Motorola 2004 10k). This campaign aims to
connect all aspects of consumers’ lives with a touch of a button. Motorola incorporates
this idea into all of their products and services through innovative technologies.
Motorola relies heavily on their research and development program in all four segments
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to help innovate new products and improve existing products. In 2005, this company
had 10% of their sales devoted in research and development expenditures, which is
about $300 million more than Motorola expensed in 2004. (Motorola 10-k 2005)
Motorola has unlimited access to creativity and innovation through its 25,000
employees working in its research and development department. With the ever
changing technology that the industry requires from Motorola, this key success factor is
will benefit them in the future, and constantly funding the research and development
department in order to stay ahead of its competitors.
The research and development teams at Motorola design the wide array of
products that are available to customers around the world. After the RAZR’s huge
success in 2004, Motorola was forced into creating something even better to maintain
its high profits. In the past year, Motorola unveiled the QWERTY, also known as the Q.
This new product offers its customers internet access, Microsoft office, and PDA
features at the tips of their fingers. The Q joins Motorola’s wide variety of sleek and
fashionable mobile devices available to customers such as the RAZR, CRAZR, RAZR v31,
and the SLVR. (Motorola 10-k 2005)
In addition to product variety, Motorola offers a great customer service as well.
You can walk-in, send them your mobile device directly or upgrade to a new one. You
can e-mail them 24 hours a day or call them from 7a.m. – 10 p.m. If a customer is not
completely satisfied with there product, for any reason, he or she can return it within 30
day of purchase. Customers are reimbursed for the shipping cost after Motorola
receives the product. You can go to any of your service providers, almost any retail
consumer electronics store, and call and order it 24/7, or buy it from the company
directly, with express shipping, online. Motorola believes that a strong and
knowledgeable customer service department is vitally important to satisfying its current
and potential customers.
These three qualities have allowed Motorola to compete effectively with
competitors, because they are key success factors. They have also helped Motorola
achieve its number two position in the global market. In the past, Motorola has
managed a portfolio of more than 3 billion dollars in order to take advantage of new
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and innovative technology and product design.(Motorola 10-k 2005) This Fortune 100
Company has had flexible delivery and timely service not only for retailers, but also
customers that have access to products and services from Motorola’s online website.
Motorola has won several awards for its quality products and won the acclaim of
millions.
Accounting Analysis
Key Accounting Policies:
In order to have an affective accounting analysis an analyst must take into
consideration several key accounting policies. The key accounting policies determine the
accuracy and quality of the firm’s accounting policies. When looking at key accounting
policies it is important to take notice of the firm’s keys success factors, and in turn
determine the reliability firms accounting policies. Motorola has classified itself as a
company focusing on differentiation, innovative design, as well as providing rich
experiences to customers and carriers. Motorola, therefore, continues to spend a large
amount of time and money on research and development, customer service, and
advertising/marketing.
Motorola’s research and development department is a primary key success
factor. The R&D department helps Motorola stay at the top of the industry, although it
is sometimes hard to estimate the total effect of R&D. In 2004 Motorola was nearly
bought out by Ericsson. However, with continuous research and development, Motorola
created the Moto Razr, a product that essentially saved the company. Motorola spent
approximately $3.7 billion dollars last year in R&D expenditures, or 10% of their net
sales. This is consistent with the industry, in which Nokia’s R&D expenditures were
11.2% of net sales (2005 Motorola 10-k)
Another key accounting policy for Motorola is customer service and warranty
expense. Motorola is offering exceptional warranty and customer service. There are
currently three different ways to make a claim on a warranty item. Customers have the
convenience of calling a representative, filling for a repair online, or by simply walking
into any of Motorola’s carriers. The company expensed a total of $500 million for
warranties and doubtful inventory. This is a consistent trend with what Motorola
21
accumulated in the previous year. Nokia, however, the biggest firm in the mobile
communications industry only allowed approximately $141 million (2005 Motorola 10-K;
Nokia 2005 form 20-F). The reason for such a large gap results from two reasons. One,
Nokia has a better quality product and two; Motorola has a better customer service.
Goodwill Motorola preformed in 2005 was $1.3 billion as stated in 2005 10-K,
while Nokia only spend approximately $856 million in 2005 (Nokia Form 20-F). This
shows that Motorola is consistent with the industry for 2005. “The goodwill impairment
test is performed at the reporting unit level and is a two-step analysis. First, the fair
value (FV) of each reporting unit is compared to its book value. If the FV of the
reporting unit is less than its book value, the company performs a hypothetical
purchase price allocation based on the reporting unit's fair value to determine the fair
value of the reporting unit's goodwill” (2005 Motorola 10-K). Motorola has partnered up
with external company that performs this calculation, making this method a more
accurate.
Accounting Flexibility:
Motorola has continually strived to stay within SEC’s regulations. The company
does so by continuously following the practices set by the SEC and maintained by
Motorola’s board. Motorola specifically utilizes its flexibility to promote its most
important assets as a company. In the future, keeping a constant state of flexibility will
increase Motorola’s success, and therefore reduce the risk that shareholders may face.
Research and development, as well as customer service are critical factors to take into
account.
The first aspect that is important to consider is the fact that managers have no
accounting discretion when it comes to research and development. The $34 million
allocated to R&D is a number that is reported on the financial statements as an
estimate. Motorola, therefore, has the flexibility to report which research and
development events and actions led to specific numbers on their financial statements.
Motorola believes that “it is critical to invest in R&D of leading technology and services
to remain competitive” (Motorola 10-K 2005). Customer service is as well a key success
22
factor that cannot be adequately measured in numerical terms. For disclosure purposes
managers report this number under the long-term intangible assets. The flexibility that
Motorola maintains in preparing values for specific assets allows for flexible information
disclosure.
The second aspect to consider is a factor that all firms have a policy such as the
depreciation policy. Motorola records depreciation using declining balance and straight-
line method based upon the useful lives of its assets. An estimation method, which
allows Motorola the flexibility to determine the ultimate useful life of its assets, results
in an estimated inventory value on the Statement of Cash Flows.
Along with the depreciation policy is the inventory policy that Motorola utilizes.
Motorola uses the FIFO inventory policy and has done so for a number of years. The
company is able to release useful information and the costs associated with inventory to
company owners. This method of inventory provides customers with products before
becoming obsolete. In addition, this leads to a constant level of the most
technologically innovative products to remain in stock. Taking this into account,
Motorola therefore has less flexibility when accounting for specific entries. We came to
the conclusion that a strict FIFO policy results in an accurate use of the FIFO method,
but restricts flexibility. In turn, it is important to note that the SFAS requires that,
“abnormal amounts of idle facility expanse, freight, handling costs, and spoilage are
charged as expenses in the period that they incurred rather than be capitalized as a
component as inventory costs” (Motorola 10-K 2005). Motorola also uses a future cash
flow analysis in order to determine the amount the assets should be impaired, another
factor that allows for increased flexibility.
Lastly, it is essential to consider the policy used for writing off goodwill. Goodwill
has been reported on the balance sheet and is a number that can change due to
managers’ discretionary decisions. Motorola does not amortize goodwill; “instead it is
tested for impairment at a minimum of once a year” (Motorola 10-K 2004). The
impairment of long-term intangible assets is, as well, reviewed for impairment when
changes occur in the company. The company can be viewed as having the flexibility to
determine which fluctuations in events cause certain asset impairments according to
23
disclosures in Motorola’s 2003, 2004, and 2005 10-Ks. Motorola’s ability to ultimately
decide the impairment of intangible assets has concluded to augmented flexibility
because of ultimately things such as negative economic trends, and declining stock
prices.
It is then clear that Motorola has been able to gauge key policies that have
allowed them to maintain a strong flexible stance. This in turn helps investors and
shareholders determine Motorola’s future performance. Disclosing crucial information,
that is based on past sales and expenses will be beneficial for owners who will be able
to more easily determine the future prosperity of Motorola.
Accounting Strategy:
When determining weather a company is aggressive or conservative in their
accounting strategy there are many things that need to be analyzed. These include
their inventory method, investments in research and development, lease obligations
either capitalized or operating, and accounting for goodwill. When looking at Motorola’s
inventory method they approximate it on a first in, first-out basis (FIFO). This would be
considered aggressive since they want to send their old production costs which are
lower to cost of goods sold in the income statement and their newer production costs
which are higher to the balance sheet in inventory. This would make sense because in
the industry Motorola is in they would want to get rid of the older inventory before they
become obsolete with the new technology that will be coming in.
If they were to use the LIFO method you would have a lot of inventory just
building up of obsolete items and you would have to consume those older product
costs. FIFO method is also aggressive in the sense that if you have a consistent selling
price and you use the FIFO method your costs will be lower since you are getting rid of
the old costs first thus making profit higher. Motorola also has to maintain a competitive
inventory system to keep up with the competition on delivery performance while
exercising this method. Management estimates inventory reserves of 18% of total
inventory, 549 million, in order to protect themselves from obsolesce and new
technology. This can be enlarged by writing down more reserves or lessened by being
24
reversed into income. (Motorola 10-K 2005) Nokia a close competitor also uses the
same inventory method and has an allowance for the same reasons. FIFO and reserves
for inventory are not unheard of in this industry.
Another quality of Motorola that makes them aggressive is how they reserve
$501 million for warranties (Motorola 2005 10K). This makes them aggressive in that
they are okay with allowing for more warranties expenses than their larger competitor
Nokia. You can look at this in different ways either they are dedicated to customer
service and will replace products easily for customers or it is that they have a poorer
quality product and have to replace them more than there competitors because of
default. Motorola does this to enhance their customer service because they are known
for excellent service, it can’t be because of quality since they are competing on
differentiation and superior quality is followed. Since this number is relatively small
compared to total liabilities they are not acquiring a huge debt on returns and defaults
therefore proving that it is for their service and not due to poor products.
Goodwill and Research and Development are also a factor to determine when
analyzing a company’s accounting strategy. Motorola acquired goodwill in the
acquisition of companies while also capitalizing research and development facilities. This
explains the high investment of research and development for Motorola’s key success
factor. The specific acquisition in research and development will help their
differentiation competitive strategy because with having more R&D it will help them be
more likely to create the most innovated product in the industry. In 2004 Motorola
acquired MeshNetworks, Inc. and Force Computers and in 2003 they acquired
Winphoria Networks, Inc. These acquisitions show that Motorola capitalized Research
and Development through them. They acquired $18 million from the companies in 2004
and $32 million from the company in 2003 on in-process research and development.
“The allocation of value to in-process research and development was determined using
expected future cash flows discounted at average risk adjusted rates reflecting both
technological and market risk as well as the time value of money.” (Motorola 10-K
2005)
25
Motorola also acquired $178 million in 2004 of goodwill from the companies
which was 61% of the total acquisitions in that year and $93 million in 2003 which was
52% of the total acquisitions in that year. There were no recorded acquisitions in 2005.
There were goodwill impairment charges of $125 million in 2004 and $73 million in
2003, but there was no goodwill impairment in 2005 due to not acquiring any in this
year. These impairment charges would then decrease the total goodwill for the years
making the balance in goodwill $53 million in 2004 and $20 million in 2003. Since there
was not any goodwill impaired in 2005 this is an aggressive accounting strategy for
2005 but, in 2004 and 2003 Motorola was exercising conservative accounting in having
impairment charges since this would make intangible assets decrease. Therefore, the
acquisition of the companies in the previous years demonstrate conservative
accounting since Motorola acquired research and development facilities that will greatly
benefit the company and make net income decrease with more R&D expenditures due
to these acquisitions. The acquirement of more goodwill is an aggressive technique
since it will increase assets while holding liabilities constant. (Data found from
Motorola’s 2005 10K)
Motorola has various pension plans such as noncontributory pension plans and
defined benefit plans. They contributed a total of $370 million total to their pension
plans in 2005. This will make expenses go up and liabilities to increase. Therefore this is
making net income lower so this is a conservative accounting strategy. Since they are
declining in their contributions compared to their $652 million in 2004 and expected
$275 million in 2006 they are becoming less conservative but still conservative since net
income is being decreased by this activity. Motorola also discusses that the funding of
their pension plans is based on the performance of the equity markets and interest
rates. If they are performing poorly and do not bring as much long-term returns that
are expected then they could be forced to pay higher contributions. Also, if the interest
rates increase they can pay higher contributions. So if there is a huge change in the
financial market their expectation for 2006 will be too low because they will pay a
higher contribution due to the market making them more conservative. (Data found
from Motorola’s 2005 10K)
26
When looking at all of these things together Motorola is mainly aggressive in
their accounting strategy. This is good for them in the sense that they are acquiring
new companies and with that more R&D and goodwill. This is also good in that they are
allowing for good customer service since they have high warranties reserved compared
to their competitors. Being conservative in their pension plans is a good thing because
they do not want their employees taking advantage of a lenient pension plan.
Motorola’s accounting strategy is efficient and works for them quiet well therefore
making them smart in their accounting choices.
Qualitative and Quantitative Analysis:
These revenue and expense diagnostics help to further analysis accounting
numbers created and generated by the telecommunications industry. Revenue
diagnostic ratios are a way to see if a company is overstating their revenue while
expense diagnostic ratios see if a company is understating their expenses. Overstating
revenue or understating expenses is not only illegal, but it also gives shareholders a
false idea of the company’s performance. Large jumps, within these ratios without
disclosed explanations would be an indicator of a company misrepresenting their
earnings. It should be noted that Ericsson is a competitor to Motorola’s mobile device
segment only. Therefore, Ericsson has lower ratios because it is not as large a company
as Motorola or Nokia. Nokia is the closest competitor to Motorola because it competes
in the same four segments as Motorola.
Revenue Diagnostics
These ratios include Net Sales/Cash from Sales, Net Sales/Accounts Receivable,
Net Sales/Inventory, and Net Sales/Warranty Liability. Each ratio involves sales in the
numerator while the denominator has an item that is related to sales. If one of these
ratios suddenly jumps upward, the component of sales (like cash or accounts
receivable) might be understated to make the company look better. The ratios help
show how well Motorola stacks up with the rest of the industry.
27
Net Sales/Cash from Sales
This ratio represents how much of Motorola’s sales are done with cash. The idle
ratio would be one so the accounts receivable would be reduced and would reduce the
liability for doubtful collection of accounts.
Net Sales/Cash From Sales 2002 2003 2004 2005 2006Motorola 1.01 1.01 1.02 1.04 1.00Nokia N/A N/A N/A N/A N/A Ericsson 1.07 1.04 0.99 0.96 1.00
Net Sales/ Cash From Sales
0.90
0.92
0.94
0.96
0.98
1.00
1.02
1.04
1.06
1.08
1.10
2002 2003 2004 2005 2006
MotorolaEricsson
These ratios shows how much cash is received compared to sales made during
the year. Motorola is decreasing their cash collected from customers because the
increase to accounts receivable is greater than the collection rate. Ericsson is
experiencing a loss in sales for the past 5 years and therefore collects less cash. Nokia
was excluded from this list because they do not list their trade accounts receivable
separately from their operating activities.
28
Net Sales/Net Accounts Receivable
The lower this ratio, the more sales that are explained by accounts receivable.
This coincides with the sales/cash from sales ratio because the sales/cash from sales
ratio decreased, which means more sales are done on credit. The more sales that are
done on account will reduce the sales/accounts receivable ratio. These two ratios move
inversely of each other, like they should be, so Motorola is not overbooking its cash
from sales or under-booking its accounts receivable.
Net sales/ Net A/R 2002 2003 2004 2005 2006Motorola 5.28 6.06 6.92 6.38 5.71Nokia 5.57 5.63 6.68 6.40 6.98Ericsson 3.99 3.68 4.04 3.68 3.48
Net Sales/Net Accounts Receivable
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
2002 2003 2004 2005 2006
MotorolaNokiaEricsson
Motorola has higher accounts receivables along with sales, but they are having
trouble collecting on these receivables. For Motorola, the sales and accounts receivable
have leveled off in the past few years after a surge in sales in 2004 due to the release
29
of the RAZR in the mobile device segment. Motorola, like Nokia, allows for customers
to buy more on credit because they have a larger range of variety among products.
Ericsson does not have as large a ratio as Motorola and Nokia because it is a much
smaller company, but they too have trouble collecting on their receivables. This
industry trend shows that the telecommunications industry can be very risky for
companies.
Net Sales/Inventory
Being in the telecommunications industry, it is vitally important not to keep a
large stock of inventory because of the rapidly growing technology. This ratio shows
how much inventory the company keeps on hand relative to the number of sales. The
higher this ratio, the less inventory the company is keeping on hand to generate high
sales. Ideally, a company in this industry would want a high Net Sales/Inventory ratio.
If this number suddenly jumped without explanation, Motorola could be hiding obsolete
inventory, which is inventory that cannot be sold and would decrease their net income
for the year if it were recognized.
Net Sales/ Inventory 2002 2003 2004 2005 2006Motorola 8.16 11.03 12.30 14.61 13.56Nokia 23.51 25.20 22.43 20.50 26.46Ericsson 10.86 10.71 9.42 7.90 8.28
30
Net Sales/ Inventory
0.00
5.00
10.00
15.00
20.00
25.00
30.00
2002 2003 2004 2005 2006
MotorolaNokiaEricsson
For the most part, when Motorola’s inventory increased, their sales increased as
well. However, in 2005, the sales increased but there was a decrease in inventory.
Motorola’s management states that the decrease in inventory “was driven by an
increase in turns by Mobile Devices [segment], primarily due to the significant growth in
net sales and effective inventory management programs” (Motorola’s 10K 2005).
Motorola also stresses the need to “maintain strategic inventory levels to ensure
competitive delivery performance to its customers against the risk of inventory”
(Motorola’s 10K 2005). In 2006, Motorola’s inventory increased by over 1 billion, so it is
unlikely that they understated their inventory in 2005 and not in 2006 if they were
trying to hide obsolete inventory.
Net Sales/Warranty Liability
In this ratio, if a company sells warranties, their ratio should stay about the same
over the years. This is because as the number of sales increase, the warranties should
increase as well. If a company’s sales were increasing without an increase to
warranties, the company could be trying to hide some liability.
31
Net Sales/ Warranty Liability 2002 2003 2004 2005 2006Motorola 72.74 64.50 62.65 73.54 80.90Nokia 254.37 187.61 248.03 226.43 306.87Ericsson N/A N/A N/A N/A N/A
Net Sales/ Warranty Liability
0.00
50.00
100.00
150.00
200.00
250.00
300.00
350.00
2002 2003 2004 2005 2006
MotorolaNokia
The warranty liability takes into account that there are defects and returns that
Motorola has to account for in their finances. Since Motorola sets aside a higher
percent for warranties, it has a much smaller ratio than Nokia. As seen in the graph,
Motorola is pretty steady as oppose to Nokia because Nokia’s sales are increasing at a
higher rate. However, Nokia’s sales increased for 2005 while their warranty expense
decreased, which means this is a possible red flag for Nokia.
Motorola sells warranties for their products, so if sales increase, warranties are
expected to increase as well. If warranties are decreasing while sales are increasing,
Motorola could be concealing their warranty liability. However, since the ratio stays
relatively stable over the years, Motorola is not understating this liability.
Expense Diagnostics
These ratios are run to see if a company is understating their expenses. These
ratios income Asset Turnover, Cash Flow from Operations/Operating Income, Cash Flow
32
from Operations/Net Operating Assets, and Pension Expense. If a company
understates their expense, they will falsely show a higher net income and higher
retained earnings. Managers within companies might understate their expenses so they
can maintain a certain level of net income and so they can appear like they are doing a
good job.
Asset Turnover
Asset turnover shows the relationship between the assets of the company and
the sales those assets generate. An efficient company would have fewer assets
producing more goods and thus higher sales. A higher asset turnover ratio would be
beneficial to a company because it shows your company is being more efficient. If a
company were trying to keep assets off the books, this ratio would be higher and the
company would appear to be more efficient than it actually is.
Asset Turnover 2002 2003 2004 2005 2006Motorola 0.75 0.72 1.01 1.03 1.11Nokia 1.29 1.23 1.29 1.53 1.82Ericsson 0.70 0.64 0.72 0.73 0.827
Asset Turnover
0.000.200.400.600.801.001.201.401.601.802.00
2002 2003 2004 2005 2006
MotorolaNokiaEricsson
33
Motorola’s sales have been increasing over the past five years despite the fact
they have been able to reduce their non-current assets, mainly their plant, property and
equipment. Motorola reduced its total plant, property, and equipment in 2003 by
almost 1/3. Motorola sold some plant, property, and equipment for $57 million, most of
which is overseas in Asia. Therefore, this ratio should be increasing over the years
because sales are increasing and assets as decreasing. Motorola is not understating the
expenses that come with assets because they are specifically reducing their non-current
assets. Motorola is steadily increasing their current assets of cash, accounts receivable,
and inventory, but they are reducing the amount of plant, property, and equipment
required to generate sales. Nokia is able to produce higher sales off of fewer tangible
assets than Motorola or Ericsson. Ericsson has a steady ratio of sales over assets.
Cash Flow From Operations/Operating Income (CFFO/OI)
Cash Flow from Operations is an important aspect for any company. It is “the
cash generated by the firm from the sale of goods and services after paying for the cost
of inputs and operations” (Palepu, p. 5-23). This ratio checks to see if the CFFO an be
explained by the company’s operating income. Therefore, it is idle for this ratio to be
low so that less cash flows are coming from investing activities. A company might
understate its operating income so it appears that they are generating more cash flows
from their operating activities instead of their investing activities.
CFFO/OI 2002 2003 2004 2005 2006Motorola 0.63 1.56 0.98 0.98 1.07Nokia 0.72 0.83 1.00 1.13 0.82Ericsson 0.47 0.79 0.68 0.50 0.52
34
CFFO/OI
0.000.200.400.600.801.001.201.401.601.80
2002 2003 2004 2005 2006
MotorolaNokiaEricsson
Motorola stays stable after 2003. The jump in 2003 was caused by a huge
increase to Motorola’s investing activities. The company spent almost 6 times as much
of the cash from operations on investing activities, which caused the cash flow from
operations to be low and operating income to be even lower.
Cash Flow from Operations/Net Operating Assets
Like Asset turnover, the higher this ratio, the more efficient the company is
being. This ratio is more specific to the managing aspect of the company. Instead of
sales, that are generated outside the company, this ratio deals with how well the
company can generate capital within the company through the proper management.
Again, this is an expense ratio because the CFFO is affected by the company’s
expenses. If a company were to understate their operating assets, it would appear that
a company was able to generate more CFFO in the firm with fewer operating assets.
CFFO/NOA 2002 2003 2004 2005 2006Motorola 0.19 0.81 1.31 2.03 1.54Nokia 1.85 2.65 2.83 3.31 2.80Ericsson 0.01 0.07 0.09 0.04 2.35
35
CFFO/NOA
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
2002 2003 2004 2005 2006
MotorolaNokiaEricsson
This ratio also shows that Motorola is not trying to hide expenses because it
coincides with their asset turnover ratio. In both ratios, the assets have decreased,
which increases the ratio. If CFFO/NOA was decreasing while asset turnover was
increasing, then there would be an inconsistency in Motorola’s accounting disclosure
that would indicate that Motorola was possibly hiding expenses in their operating
assets.
Pension Expense/General Selling and Administrative Expenses
This ratio has to do with the personnel within a company. The more
administrative expenses that a company has, the lower their pension rate will be. A
company might hide their SG&A because they want to show a lower pension ratio. The
pension ratio would reflect a liability for the company and fewer liabilities are preferable
in a company.
Pension Expense/ SG&A 2002 2003 2004 2005 2006Motorola 0.04 0.08 0.08 0.07 0.06Nokia 0.07 0.05 0.09 0.09 0.09Ericsson 0.37 0.34 0.62 0.19 0.02
36
Pension Expense/ SG&A
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
2002 2003 2004 2005 2006
MotorolaNokiaEricsson
This ratio relates the amount of administrative costs to pension expenses. This
ratio should remain steady for the company unless drastic administrative changes
occur. Motorola uses a 6.0% discount rate for their pension obligations and all
employees are eligible for the Regular Pension Plan after one year of service. Nokia
and Motorola both have a steady pension expense of less than 10% of all selling and
administrative expenses. In this case, Ericsson does not have as high of an
administrative expense because it is not as large a company as Motorola or Nokia.
Ratio Analysis and Forecasted Financial Statements:
There are two more aspects to look at before valuing a company: ratio analysis
and forecasting of financial statements. “The objective of a ratio analysis is to evaluate
the effectiveness of the firm’s policies in each area: operating management, investing
management, financial strategy, and dividend policies.” (Palepu p. 5-1) The results
from these ratios can spur questions for analysts or for shareholders to question how
well the firm is being run. The second aspect of prospective analysis, or forecasting, is
very important as well. Forecasting allows managers to see how long they can maintain
their current levels of performance or what areas they need to improve on in the future.
37
The information from the forecasted financial statements will be used later in the
valuation models.
Ratio Analysis:
In order to efficiently value Motorola and its competitors based on their financial
condition and performance levels, a ratio analysis is required. The ratio analysis is used
to determine if Motorola and its competitors are operating efficiently. Five years of
financial statement data will be used in the ratios to determine if the company has a
trend of operating favorably or unfavorably. There are three categories of ratios:
liquidity, profitability, and capital structure. Each category will be examined and their
ratios analyzed. These ratios will help determine how well Motorola does compared to
the rest of the telecommunications industry. Nokia’s financial statements are presented
in Euros and the values for their ratios had to be converted to dollars. Ericsson’s
financial statements are presented in Swedish Krona and the values for their ratios also
had to be converted to dollars.
Liquidity
Liquidity ratios relate how well a firm can maintain its cash resources to cover its
current obligations. A company wants these ratios to be increasing over time. There are
five liquidity ratios: current ratio, quick asset ratio, accounts receivable turnover,
inventory turnover, and working capital turnover.
Current Ratio
The current ratio, which can be defined as current assets divided by current
liabilities, determines how many assets they have to cover every dollar of debt. Current
assets are cash, accounts receivable, securities, any prepaid expenses, and inventory.
Current liabilities include current notes payable, accounts payable, and accrued
liabilities. This ratio is favorable when high and increasing over the five years. If the
number is above one, this indicates that the company has enough assets to cover their
liabilities. Therefore, the higher the number, the more assets the firm has to cover their
38
liabilities. Also, if the number is increasing over the years at a steady rate, this means
that the company is increasing their assets, decreasing their liabilities, or both at a
steady rate. For Motorola, their current asset ratio increased from 2002-2005 because
their accounts receivable and inventory increased by more than their increase in
accounts payable. In 2006 the ratio dropped because current liabilities increased by
more than their current assets.
Current Ratio 2002 2003 2004 2005 2006Motorola 1.75 1.90 1.99 2.23 2.01Nokia 2.09 2.43 2.45 1.96 1.83Ericsson 2.24 2.41 2.99 1.91 2.16Industry 2.03 2.25 2.48 2.03 2.00
Current Ratio
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
2002 2003 2004 2005 2006
Years
MotorolaNokiaEricssonIndustry Average
The above graph compares Motorola and the industry average. In 2002,
Motorola’s current ratio started to increase closer to the industry average and between
2004 and 2005 the current ratio passed the industry average, while Nokia and
Ericsson’s current ratios dropped below the industry average. The increase in the
39
current ratio states that Motorola has more resources to pay back upcoming debt
obligations compared to the industry.
Quick Asset Ratio
The quick asset ratio is quick assets, assets that can be turned into cash within
twenty-four hours, divided by current liabilities. Quick assets do not include inventory or
prepaid expenses because those cannot be quickly turned into cash if needed. This ratio
determines if the company can pay its debt if it had to liquidate tomorrow. This ratio is
a good test not only to see how liquid the firm is, but also how much of their assets is
tied up in inventory. If the company has high inventory, the quick asset ratio is going to
be much lower than the current asset ratio. For Motorola, their quick asset ratio
increased from 2002 to 2003, but suddenly dropped in 2004 because cash was reduced
by more than a third.
Quick Asset Ratio 2002 2003 2004 2005 2006Motorola 1.12 1.24 0.70 0.76 1.50 Nokia 0.82 0.77 0.69 0.71 0.73 Ericsson 1.22 1.57 1.58 1.22 0.73 Industry 1.05 1.19 0.99 0.90 0.99
Quick Asset Ratio
0.000.200.400.600.80
1.001.201.401.601.80
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry Average
40
In the above graph Motorola was moving with the industry from 2002-2003 but
dropped below the industry from 2003-2005 but then had a huge jump in 2006 this is
due to a decrease in cash and a larger increase in its current liabilities than its quick
assets. The drop from 2003 to 2004 in the industry means that it has fewer quick assets
to cover their debt and a relative amount of assets tied up in inventory. Since mid
2003-2005 the ratio was below one this means that Motorola would have to use other
resources if they wanted to pay their debt within 24 hours.
Accounts Receivable Turnover
Accounts receivable turnover, inventory turnover and working capital turnover
relate to how well a company can maintain its liquidity. The accounts receivables
turnover describes how much of your account receivables are collected in that year.
This ratio is defined as sales divided by accounts receivable. The higher this ratio is, the
faster the more the company is collecting on their accounts and the more efficient the
company is being. Day’s supply of receivables is defined as 365 divided by the
receivables turnover. Therefore, a company wants their days supply to be as low as
possible or decreasing with time. Decreasing the days' supply of receivables means the
company is collecting its money quicker and making its cash cycle shorter. The faster a
company can collect, the faster the company can put the money back into the cycle and
produce more goods. Motorola’s accounts receivable turnover is somewhat jumpy. In
2003, the ratio jumped by almost one and then increased again in 2004 this made the
days receivables turnover decrease, allowing Motorola to be able to collect its money
quicker.
Accounts Receivable Turnover 2002 2003 2004 2005 2006Motorola 5.28 6.06 6.92 6.38 5.71Nokia 5.57 5.63 6.68 6.40 6.98Ericsson 3.9 3.9 3.9 3.9 3.9Industry 4.92 5.20 5.83 5.56 5.53
41
Accounts Receivable Turnover
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry
Days Until Collection of A/R 2002 2003 2004 2005 2006Motorola 69.14 60.25 52.73 57.25 63.92Nokia 65.48 64.82 54.65 57.07 52.26Ericsson 91.49 99.15 90.28 99.15 104.85Industry 75.37 74.74 65.89 71.16 73.68
A/R Turnover Days
0.00
20.00
40.00
60.00
80.00
100.00
120.00
2002 2003 2004 2005 2006
Days Motoroladays Nokiadays ericssonindustry days
When looking at the industry average in the above graph for accounts receivable
turnover days, Motorola is below the rest of the industry meaning that it collects its
42
receivables quicker than average. In turn, allowing the cash-to-cash cycle to be
shorter, a desirable factor. The industry average is remarkably higher due to Ericsson’s
inability to collect on its receivables.
Inventory Turnover
The Inventory turnover ratio is defined by cost of goods sold divided by
inventory. In other words, it describes how well you can sell your inventory. The higher
this ratio, the lower the inventory days supply will be, which means less inventory
sitting around. The faster a company’s inventory turnover, the more efficient the
company will be. For Motorola, their inventory increased over the past five years by a
little more than one point each year and therefore reduced their days' supply of
inventory by almost 7 days a year.
Inventory Turnover 2002 2003 2004 2005 2006Motorola 5.49 7.46 8.24 9.94 9.54Nokia 14.31 14.75 13.90 13.31 17.85Ericsson 7.35 7.20 5.06 4.29 4.87Industry 9.05 9.80 9.06 9.18 10.75
Inventory Turnover
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
20.00
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry
43
Days Supply of Inventory 2002 2003 2004 2005 2006Motorola 66.53 48.95 44.32 36.72 38.28Nokia 25.50 24.75 26.27 27.41 20.45Ericsson 49.66 50.72 72.13 85.12 75.00Industry 47.23 41.48 47.57 49.75 44.57
Inventory Turnover Days
0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
2002 2003 2004 2005 2006
Days Motoroladays Nokiadays ericssonIndustry Days
Motorola compared to the industry in the above graph is above the average until
mid-2003. This entails that Motorola was taking longer than average to utilize its
inventory. In 2003 Motorola falls below industry average and continues to decrease
until 2006 while Ericsson continues to increase. This means Motorola is utilizing their
inventory system more efficiently than the average and Ericsson is having some
problems with theirs.
Working Capital Turnover
The working capital turnover is defined as sales divided by working capital. If this
ratio is increasing, this could be the result of an increase in sales while holding working
capital constant, or a decrease in working capital while holding sales constant. Reducing
working capital could be the result reducing the company’s current assets, perhaps by
44
better management of inventory, or by increasing their liabilities. Reducing current
assets while holding sales constant would mean the company is able to generate more
sales with fewer assets, which makes the company more efficient. Increasing liabilities
without increasing your assets could be hazardous to the company. While this would
increase your working capital, it would mean you are generating more debt for the
same amount of sales. Motorola’s working capital is decreasing because Motorola’s
current assets are increasing and their current liabilities are increasing from 2002 to
2005 despite sales increasing.
Working Capital Turnover 2002 2003 2004 2005 2006Motorola 3.20 2.73 2.98 2.40 2.76 Nokia 3.27 2.50 2.54 3.68 4.88 Ericsson 1.84 0.15 1.45 2.01 2.19 Industry 2.77 1.79 2.32 2.70 3.28
Working Capital Turnover
0.00
1.00
2.00
3.00
4.00
5.00
6.00
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry Average
Motorola’s working capital is above the industry until mid-2004 this means that
Motorola’s current assets are increasing at a higher rate than the industry. This ratio
should be increasing for the company to become more liquid and since the industry and
Motorola is decreasing this is not favorable yet Motorola is efficient in being above the
industry average.
45
Profitability
Profitability ratios describe a company’s operating efficiency, asset productivity,
and rate of return on assets and equity. Operating efficiency includes gross profit
margin, operating profit margin, and net profit margin. A firm would want gross profit
and net profit margins to be increasing and operating profit margin to decrease to
achieve maximum sales at the lowest cost. Asset productivity is based off of the asset
turnover ratio. The higher the asset turnover ratio, the more sales are generated for
every dollar of assets. Return on asset and return on equity are desired to increase over
time as well.
Gross Profit Margin
The gross profit margin is defined as gross profit divided by sales. This ratio
determines how much revenue is generated from the cost of producing its goods and
services. A company wants their gross margin to increase so that they are getting more
revenue for each good they produce.
Gross Profit Margin 2002 2003 2004 2005 2006 Motorola 32.79% 32.40% 33.06% 31.97% 29.68% Nokia 39.11% 41.48% 38.04% 35.04% 32.54% Ericsson 28.50% 33.09% 46.30% 41.79% 41.23% Industry 33.47% 35.66% 39.13% 36.27% 34.48%
46
Gross Profit Margin
0%
5%
10%
15%
20%
25%30%
35%
40%
45%
50%
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry Average
In the above graph, Motorola is below the industry average, but fairly close to
Nokia, which is their closest competitor. Motorola and Nokia stay constant with their
gross profit, which means they are operating at the same level. Motorola is decreasing
as the years progress, which means they need to find a cheaper way to produce their
products to stay ahead in this industry.
Operating Profit Margin
The operating profit margin is defined as selling and administrative expenses
divided by sales. This ratio should be decreasing so that the firm can spend less to
generate their sales. The less a company has to spend to generate sales, the more
efficient the company is and the more money the company has to give to shareholders,
or debt-holders.
Operating Profit Margin 2002 2003 2004 2005 2006 Motorola 17.04% 14.19% 11.86% 10.47% 10.50% Nokia 10.76% 11.42% 10.17% 8.66% 8.06% Ericsson 20.56% 20.34% 12.31% 11.07% 12.05% Industry 16.12% 15.32% 11.44% 10.07% 10.20%
47
Operating Profit Marginn
0%
5%
10%
15%
20%
25%
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry Average
Motorola’s operating profit margin has been decreasing in recent years. This is
due to large increase in sales with a small increase to selling and administrative
expenses. When compared to the industry average Motorola is about following the
same trend as the industry. As time goes on, Motorola was constantly decreasing until it
is within 1 or 2 percent from the rest of the industry.
Net Profit Margin
The net profit margin is defined by net income divided by sales, which should be
increasing because it defines how much profit is generated for every dollar in sales.
Net Profit Margin 2002 2003 2004 2005 2006 Motorola -10.61% 3.86% 4.89% 12.43% 8.54% Nokia 12.00% 13.91% 11.42% 10.48% 10.47% Ericsson -13.04% -9.24% 14.42% 16.11% 14.87% Industry -3.88% 2.84% 10.24% 13.00% 11.29%
48
Net Profit Margin
-15%
-10%
-5%
0%
5%
10%
15%
20%
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry Average
After suffering a decrease to this margin in 2002, Motorola increased its net
income dramatically in 2003. In 2005, Motorola almost tripled its net income, which put
it right with Nokia and the rest of the industry through 2006.
Asset Productivity
Asset productivity is based on the asset turnover ratio, which is defined as sales
divided by total assets. Motorola’s asset turnover is decreased from 2002 to 2003, but
suddenly increased in 2004 and increased again in 2005 and 2006. In 2004, Motorola’s
asset turnover ratio jumped past one because they increased sales by more than $10
billion and was able to decrease total assets by decreasing their long-term assets.
Motorola’s sales increased by more than their total assets so their asset turnover ratio
increased again.
Asset Turnover 2002 2003 2004 2005 2006Motorola 0.75 0.72 1.01 1.03 1.11Nokia 1.29 1.23 1.29 1.53 1.82Ericsson 0.70 0.64 0.72 0.73 0.83Industry 0.91 0.87 1.01 1.10 1.25
49
Asset Turnover
0.000.200.400.600.801.001.201.401.601.802.00
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry Average
In the above graph Motorola is compared to the industry with asset utilization.
Motorola is below industry until 2003 and moves up with the average in 2004 but then
drops below the industry in 2005 and 2006. This means that Motorola is less efficient
when using their assets to produce sales compared to the industry. This jump in Nokia
is due to its sales jumping 8 billion in 2004 to 2005. Nokia was utilizing their assets
efficiently to produce sales.
Return on Asset (ROA)
The return on assets is defined as net income divided by total assets balance at
the beginning of the year. This helps determine how much of their assets were able to
generate earnings. The more profit a company can earn with fewer investments, the
more efficient the company is being. In 2003, Motorola was able to post a net income,
but their ROA is still low because they had lots of assets. In 2005, the company posted
more than $4 billion for net income and increased their ROA because they reduced their
total assets in 2004.
Return on Assets 2002 2003 2004 2005 2006 Motorola -7.44% 2.86% 4.78% 14.82% 10.27% Nokia 18.92% 21.04% 15.19% 13.72% 21.53%
50
Ericsson -11.45% -6.29% 11.25% 11.23% 14.67% Industry 1.43% 5.71% 6.72% 11.19% 11.19%
Return on Assets
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry Average
In the above graph Motorola is compared to the industry based on return on
asset ratio. Motorola has a negative return on assets ratio in 2002- mid-2003 due to
their net loss. In 2003 – 2005 they had an increase in income making them closer to
the average of the industry. In 2006 Motorola’s ROA dropped significantly due to a
decrease in their net income from 2005. In 2005 Motorola outperforms the industry
average due to net income tripling in value. Nokia’s return on assets ratio is higher than
the rest of the industry this makes the industry average slightly higher than it would be
if it were more along with Motorola and Ericsson this is due to them being a more
efficient company.
Return on Equity (ROE)
The return on equity compares net income divided by owner’s equity from the
beginning of the year. Stockholders want this ratio to increase so they can receive a
higher return for the money they invest in the company. Motorola’s ROE jumped from
negative to positive in 2003 due to net income in this year instead of a net loss from
the pervious year. In 2005, the ROE jumped also because of another large increase to
51
net income in 2005 and smaller change to owner’s equity in 2004. The drop in 2006 is
due to a decrease in net income.
Return on Equity 2002 2003 2004 2005 2006 Motorola -18.15% 7.95% 12.07% 34.34% 21.96% Nokia 31.42% 36.36% 29.55% 29.11% 38.36% Ericsson -3.19% -2.05% 4.72% 3.99% 5.05% Industry 0.55% 16.34% 12.51% 21.51% 21.51%
Return on Equity
-30.00%
-20.00%
-10.00%
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry Average
In comparing the return on equity of Motorola and the industry in the above
graph you find that Motorola was the most jumpy of the competitors in the industry.
This is due to the huge jumps in Net Income for Motorola and not a big change in
shareholders equity. This would turn shareholders away in the early stages of Motorola
compared to its competitors. If you were to look at Motorola in 2005 shareholders
would be confident in investing in Motorola compared to the rest of the industry since
the return on their investments would be highest with them.
52
Capital Structure Ratios
Capital structure deals with how the company is financed; either debt or equity.
To see the capital structure of the telecommunications industry, three ratios are used:
debt to equity, times interest earned, and debt service margin.
Debt to Equity Ratio
Debt to equity ratio is total liabilities divided by total owner’s equity. A decrease
to this ratio indicates that less of the firm is financed by debt and more is financed by
equity. Therefore, a firm would rather have money from their stockholders than from
their debt holders. For Motorola, their debt to equity ratio is decreasing because as the
years progress, more of the company is being financed by the stockholders than the
debt-holders. Motorola was able to increase their owner’s equity by more than $3 billion
while only increasing their total liabilities by $1 billion in 2005, which explains the huge
drop in their 2005 debt to equity ratio. In 2006 the increase is due to a larger increase
in total liabilities than the increase in owner’s equity.
Debt to Equity Ratio 2002 2003 2004 2005 2006Motorola 1.77 1.53 1.32 1.14 1.25 Nokia 0.61 0.56 0.57 0.79 0.88 Ericsson 1.83 2.02 1.37 1.04 0.78 Industry 1.41 1.37 1.09 0.99 0.97
53
Debt to Equity ratio
0.00
0.50
1.00
1.50
2.00
2.50
2002 2003 2004 2005 2006
MotorolaNokiaEricssonIndustry Average
In the above graph, Motorola’s debt to equity ratio has been decreasing since
2002 while the rest of the industry’s ratios have increased. This determines that
Motorola is ahead of the industry in being the top company financed by their equity
more than their debt. In 2002 and 2004 Motorola was right with the rest of the industry
therefore they are right on average in these years.
Times Interest Earned
Times interest earned describes how well a company can pay for their interest
expense with their operating income. Anywhere between 4 and 7 is a good number for
the company, but bigger is better for this ratio. Since less of Motorola is being financed
by debt, their interest expense will also decrease. In this case, Motorola’s time’s interest
earned decreased in 2005 to 2006 due to a large decrease in their income from
operations. This means that they are less able to use their income to cover interest
charges. The large jump from 2003 to 2004 is due to the large 2 billion dollar jump in
their operating income.
Times Interest Earned 2002 2003 2004 2005 2006Motorola 5.11 4.33 15.74 14.45 0.00 Nokia 111.22 200.48 196.85 257.66 0.00 Ericsson N/A N/A N/A N/A N/A
54
Industry 58.16 102.40 106.29 136.06 0.00
Times Interest Earned
0.002.004.006.008.00
10.0012.0014.0016.0018.00
2002 2003 2004 2005 2006
Motorola
Without Ericsson and Nokia publishing interest expense, we could not compare
them in the industry. Due to the poor disclosure by Motorola’s competitors, computing
an industry average for the times interest earned ratio was unfeasible.
Debt Service Margin
The debt service margin ratio shows how much of the operating income can pay
the principal amount of long-term assets. Anything-below one shows that a firm does a
poor job in paying for their debt with their income from operations. Three is a better
number to be at, but bigger is better for this ratio as well. The higher the number, the
less operating income a firm has to use to pay for their debt. Motorola’s debt service
margin has also been increasing at a steady rate because their liabilities are not
increases by as much as their operating income. Less of the company is financed by
debt so there is less money that must be used to pay for that debt.
Debt Service Margin 2002 2003 2004 2005 2006Motorola 0.71 2.22 4.28 10.28 1.93 Nokia N/A N/A N/A N/A N/A Ericsson N/A N/A N/A N/A N/A
55
Debt Service Margin
0.00
2.00
4.00
6.00
8.00
10.00
12.00
2002 2003 2004 2005 2006
Motorola
The above graph only includes Motorola and not the industry average or any of
the competitors for the debt service margin. There were not enough resources in the
financial statements of Nokia and Ericsson to compare Motorola to the industry and
competitors.
Sustainable Growth Rate and Internal Growth Rate
The Sustainable Growth Rate (SGR) is the most a company can grow without
having to borrow. The Sustainable Growth Rate in made up of the Internal Growth
Rate (IGR) by 1+D/E. The IGR is the rate at which a company can grow at while
maintaining financial stability. (Palepu 5-19) As indicated above the SGR and IGR move
together, because of the fact IGR is in the SGR formula.
SGR=IGR(1+D/E)
2002 2003 2004 2005 2006Motorola -23.64% 4.54% 26.53% 28.96% 28.17%Nokia 18.63% 18.37% 8.89% 11.26% 21.01%Ericsson -32.53% -19.02% 26.59% 22.45% 24.95%
IGR=ROA(1-Dividends/NI)
56
2002 2003 2004 2005 2006Motorola -8.53% 1.80% 11.44% 13.55% 12.51%Nokia 11.54% 11.76% 5.65% 6.27% 11.20%Ericsson -11.50% -6.31% 11.23% 10.99% 14.03%
Ericsson is considered one of Motorola’s competitors but is not a main
competitor, which is why its ratios are so different. In 2003 Motorola made a huge
comeback and continued to increase in 2004-2005. In 2005 Motorola is almost the
same as its top competitor Nokia.
Forecasting:
Companies use forecasting to determine what the future of the company looks
like financially. The previous years data is used to determine the trends that can be
applied to the future. By seeing how your company performs in the past, it is easier to
determine how it will perform in the future. Forecasting forces a company to look at
their past activities and find where they need to improve. However, forecasting has
error because it is impossible for a company to grow at a specific rate for the next ten
years. All three financial statements (Income, Balance Sheet, and Statement of Cash
Flows) were forecasted out for the next ten years for Motorola. When forecasting out a
company’s financial statements, the earlier years are more important. A major
forecasting error in the beginning years could be hazardous to a company’s future,
whereas a forecasting error in the latter of the ten years would not be as hazardous.
57
Income Statement 2001-2006 and Forecasted Income Statement from Q1 2007, 2007 thru 2016
2001 2002 2003 2004 2005 2006 FORE2006 Error Net Sales $30,486 $23,422 $23,155 $31,323 $36,843 $42,879 $43,335.78 ($456.78) Cost of Goods Sold $23,121 $15,741 $15,652 $20,969 $25,066 $30,152 $27,547.53 $2,604.47 Gross Profit Margin $7,365 $7,681 $7,503 $10,354 $11,777 $12,727 $15,788.25 ($3,061.25) Research and Development $4,275 $2,774 $2,979 $3,412 $3,680 $4,106 $4,118.75 ($12.75) Sales, General & Administrative $4,919 $3,991 $3,285 $3,714 $3,859 $4,504 $4,396.89 $107.11 Interest Income (Expense) $413 $355 $294 $199 $71 $326 $71.29 $254.71 Income Before Tax $5,511 $3,446 $1,293 $3,112 $6,412 $4,610 Operating Income $5,803 $1,813 $1,273 $2,992 $4,605 $4,092 $5,112.73 ($1,020.73) Net Income ($3,937) ($2,485) $893 $1,532 $4,578 $3,661 $4,901.10 ($1,240.10) Sales Growth Percent -23.2% -1.1% 35.3% 17.6% 16.4%
Q1 2007 2007
Adjusted for Loss
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Net Sales 1666.49 $49,903.88 $49,903.88 $58,079.65 $67,594.85 $78,668.94 $91,557.30 $106,557.16 $124,014.45 $144,331.77 $167,977.69 $195,497.53 COGS 820.71 $33,106.80 $33,106.80 $35,910.88 $45,426.08 $49,410.62 $62,298.98 $67,942.06 $85,399.35 $93,367.61 $117,013.53 $128,235.08 Gorss Profit 845.78 $16,797.08 $16,797.08 $22,168.77 $22,168.77 $29,258.32 $29,258.32 $38,615.10 $38,615.10 $50,964.16 $50,964.16 $67,262.45 Research and Development $4,106.00 $4,106.00 $4,579.48 $5,107.57 $5,696.54 $6,353.44 $7,086.09 $7,903.22 $8,814.58 $9,831.03 $10,964.69 Sales, General & Administrative $4,504.00 $4,504.00 $4,996.97 $5,543.89 $6,150.67 $6,823.87 $7,570.75 $8,399.37 $9,318.69 $10,338.63 $11,470.20 Income Before Tax $4,610.00 $4,610.00 $4,654.01 $4,698.45 $4,743.30 $4,788.59 $4,834.31 $4,880.46 $4,927.06 $4,974.10 $5,021.59 Operating Income 521.58 $4,092.00 $4,092.00 $4,092.00 $4,092.00 $4,092.00 $4,092.00 $4,092.00 $4,092.00 $4,092.00 $4,092.00 $4,092.00 Net Income ($915.25) $3,661.00 $2,745.75 $3,038.02 $3,361.41 $3,719.22 $4,115.11 $4,553.15 $5,037.81 $5,574.07 $6,167.40 $6,823.89
58
Income Statement
In order to forecast out the next ten years, we created a common size income
statement by dividing all the aspects of the income statement by net sales for the past
five years. This allowed us to see the trends of the accounts, whether they are
increasing, decreasing, or not changing over the past five years. Since sales and cost
of goods sold are a large portion of the income statement, their percentages are much
higher. Therefore, we could not use the average percentage of the five years because
the company would grow at 100% for sales and more than 60% for cost of goods sold.
Instead, we used an average growth rate to forecast sales and subtracted gross profit
from sales to get cost of goods sold. The sales growth rate used was 16.4%, the same
as the growth for 2006. In Motorola’s 2006 10K, they estimate that the growth rate for
sales is about 10%. A higher growth rate was used for sales because Motorola uses
aggressive accounting so we were aggressive in our forecasted sales. When done this
way, the cost of goods sold stays around 60% of sales for the ten years. Gross profit
was then grown by almost 32% every year. Net income was difficult to forecast out
because it is not a stable increase or decrease in the past 5 years. Therefore, we used
an average of 2005 and 2006’s net income because they were the closest to each
other.
According to news reports, Motorola is said to post a loss for the first quarter of
2007. (Mercurynews.com) Because of this unexpected event, the forecasts for the first
quarter of 2007 and the end of the year balance had to be adjusted. Therefore, this
information was used to adjust the results for the 2007 income statement. The first
quarter forecasted net income was changed to a net loss and was then subtracted from
the forecasted net income for 2007 to adjust for the loss of the quarter. This impacted
the forecasted net income for the net 10 years, not just the income for 2007.
59
Balance Sheet for 2001 thru 2006 and Forecasted Balance Sheet for Q1 2007, 2007 thru 2010
* in millions of dollars 2001 2002 2003 2004 2005 2006
FORE 2006 Error
Q1 2007 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Assets Cash $6,082 $6,507 $7,790 $2,846 $3,774 $3,212 $4,119 -$907 $343 $3,506 $3,827 $4,177 $4,560 $4,977 $5,433 $5,930 $6,473 $7,065 $7,712 Sigma Funds N/L N/L N/L $7,710 $10,867 $12,204 Short Term Investments N/L N/L N/L $152 $144 $224 Receivables $4,583 $4,437 $3,822 $4,525 $5,779 $7,509 $6,751 $758 $727 $8,772 $10,248 $11,972 $13,985 $16,338 $19,086 $22,297 $26,047 $30,429 $35,547 Inventory $2,756 $2,869 $2,099 $2,546 $2,522 $3,162 $2,742 $420 $195 $3,438 $3,739 $4,066 $4,421 $4,807 $5,227 $5,684 $6,181 $6,721 $7,309 Deferred Income Taxes $2,633 $5,470 $4,137 $3,894 $2,390 $1,731 Other Current Assets $1,015 $904 $955 $1,795 $2,393 $2,933 $2,525 $408 $3,095 $3,266 $3,447 $3,637 $3,838 $4,050 $4,274 $4,510 $4,760 $5,023
Current Assets $17,069 $20,187 $18,803 $23,468 $27,869 $30,975 $16,138 $14,837 $32,746 $36,601 $40,909 $45,725 $51,109 $57,125 $63,850 $71,367 $79,769 $89,160 Net Property Plant & Equipment $8,913 $6,104 $2,473 $2,332 $2,271 $2,267 $2,417 -$150 $167 $2,412 $2,567 $2,732 $2,907 $3,094 $3,293 $3,504 $3,729 $3,968 $4,223 Investments N/L N/L N/L $3,241 $1,654 $895 $1,746 -$851 $945 $997 $1,053 $1,112 $1,173 $1,239 $1,308 $1,380 $1,457 $1,538 Deferred Income Taxes N/L N/L N/L $2,353 $1,245 $1,325 Other Assets N/L N/L N/L $1,881 $2,610 $3,131 $2,793 $338 $3,351 $3,587 $3,839 $4,109 $4,397 $4,706 $5,037 $5,391 $5,770 $6,176
Total Long Term Assets $8,913 $6,104 $2,473 $9,807 $7,780 N/L $6,956 $10,391 $11,614 $12,981 $14,510 $16,218 $18,127 $20,261 $22,646 $25,312 $28,292 Total Assets $25,982 $26,291 $21,276 $33,275 $35,649 $38,593 $23,095 $15,498 $1,779 $43,136 $48,215 $53,891 $60,235 $67,326 $75,252 $84,111 $94,014 $105,081 $117,452
Liabilities Notes Payable N/L N/L N/L $717 $448 $1,693 Accounts Payable $2,434 $2,268 $2,458 $3,330 $4,406 $5,056 $5,197 -$141 $5,964 $7,035 $8,299 $9,790 $11,548 $13,622 $16,069 $18,955 $22,360 $26,376 Accrued Liabilities N/L N/L N/L $6,556 $7,634 $8,676 $7,634 $1,042 $220 $8,676 $8,676 $8,676 $8,676 $8,676 $8,676 $8,676 $8,676 $8,676 $8,676
Total Current Liabilities $2,434 $2,268 $2,458 $10,603 $12,488 $15,425 $18,035 -$2,610 $454 $14,640 $15,711 $16,975 $18,466 $20,224 $22,298 $24,745 $27,631 $31,036 $35,052 Common Equity N/L $6,947 $7,017 N/L N/L N/L Long Term Debt $8,372 $7,189 $6,673 $4,581 $3,806 $2,704 $4,790 -$2,086 $107 $3,403 $4,283 $5,390 $6,784 $8,538 $10,746 $13,525 $17,021 $21,422 $26,961 Other Liabilities N/L N/L N/L $2,407 $2,682 $3,322
Total Long Term Liabilities N/L $8,818 $7,542 $5,298 $4,254 N/L $4,790 $3,403 $4,283 $5,390 $6,784 $8,538 $10,746 $13,525 $17,021 $21,422 $26,961 Total Liabilities $19,707 $19,913 $19,357 $17,591 $18,976 $21,451 $22,825 -$1,374 $781 $28,602 $29,882 $30,685 $30,769 $29,807 $27,359 $22,843 $15,484 $4,258 -$12,181
Shareholder's Equity Stock N/L N/L N/L $7,343 $7,508 $7,197 $7,197 Additional Paid-In-Capital N/L N/L N/L $4,321 $4,691 $2,509 $2,509 Retained Earnings $5,434 $2,582 $3,103 $1,722 $5,897 $9,086 $7,651 $1,435 $11,789 $15,295 $19,844 $25,746 $33,404 $43,340 $56,231 $72,956 $94,656 $122,809
Total Stockholders Equity $13,691 $11,239 $12,689 $13,331 $16,673 $17,142 $270 $16,872 $651 $14,534 $18,333 $23,205 $29,466 $37,519 $47,893 $61,269 $78,530 $100,823 $129,633
Total Liabilities and Stockholder's Equity $33,398 $31,152 $32,046 $30,922 $35,649 $38,593 $23,095 $15,498 $1,431 $43,136 $48,215 $53,891 $60,235 $67,326 $75,252 $84,111 $94,014 $105,081 $117,452
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Balance Sheet
To properly forecast the next ten years of the balance sheet, we created a
common size balance sheet. This time we took all assets as a percentage of total
assets, all liabilities as a percentage of total liabilities, and all stockholder’s equity items
as a percentage of total stockholders equity. As seen on the combined balance sheets,
Motorola did a poor job of distinguishing items on its balance sheet between 2001-
2003. However, most of these items are peanuts when compared to the rest of the
balance sheet and were not forecasted out. Therefore, for all items that could be
forecasted out, they were forecasted out based on the average of the percent change
in each item. Total assets were found by finding an average growth rate of assets of
about 11.7%. Since there was not a steady growth between the five years, the growth
for 2005 and 2006 were used to find the growth rate for 2007 and beyond. Current
Assets were found to be a percentage of total assets and were forecasted out as so.
Non-current assets were then found by subtracting current assets from total assets.
This was a better measure of forecasting out total assets because asset turnover shows
the relationship between sales and assets. To find total stock holder’s equity, the
current year’s net income was added to the previous years retained earnings. Lastly, to
find total liabilities, total stockholder’s equity was subtracted from total assets.
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Cash Flow Statement for 2001-2007 and Forecasted Cash Flow Statement for
Quarter 1 2007, 2007 thru 2010
in millions of dollars 2001 2002 2003 2004 2005 2006 FORE2006 Error Operating Net Earnings ($3,937) ($2,485) $893 $1,532 $4,578 $3,661 $4,901.10 ($1,240.10) Loss from Discontinued Operations $35 ($567) $59 $400 Earnings from Continuing Operations $928 $2,099 $4,519 $3,261 Depreciation and Amortization $2,552 $2,108 $818 $659 $613 $558 Charges for Reorganization of Business $4,786 $2,627 $158 $151 $209 Gains on Sales of Investments and Business ($1,931) ($96) ($539) ($460) ($1,861) ($41) Deferred Income Taxes ($2,273) ($1,570) ($160) $456 $1,000 $838 Accounts Receivable $2,445 $155 ($140) ($551) ($1,303) ($1,775) Inventories $1,838 ($102) ($34) ($399) ($19) ($718) Other Current Assets $249 $39 $109 ($780) ($721) ($388) Accounts Payable and Accrued Liabilities ($3,030) ($980) $576 $1,840 $2,405 $1,654 Other Assets and Liabilities $25 $252 $276 ($105) ($388) $215
Net Cash from Operating Activities $1,976 $1,339 $1,991 $3,066 $4,605 $3,499 $4,990.53 ($1,491.53) Net Cash from Investing Activities ($2,477) ($251) $64 ($1,596) ($2,368) ($1,048) Free Cash Flows ($501) $1,088 $2,055 $1,470 $2,237 $2,451
in millions of dollars Q1 2007 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Operating Net Earnings $686.44 $2,745.75 $3,038.02 $3,361.41 $3,719.22 $4,115.11 $4,553.15 $5,037.81 $5,574.07 $6,167.40 $6,823.89
Net Cash from Operating Activities $947.98 $3,791.94 $4,109.40 $4,453.44 $4,826.28 $5,230.34 $5,668.23 $6,142.77 $6,657.05 $7,214.38 $7,818.37 Net Cash from Investing Activities ($1,115.26) ($1,186.83) ($1,263.00) ($1,344.05) ($1,430.31) ($1,522.10) ($1,619.78) ($1,723.73) ($1,834.35) ($1,952.07)
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Statement of Cash Flows
Although there are several items on the cash flow statement, not all the
items were forecasted out because they are too volatile over the past five years.
Motorola’s operating cash flow was forecasted out as well as their net earnings
(from the forecasted income statement). Since cash flow from operating activities
(CFFO) is so hard to forecast out, it is first compared to net income, operating
income, and sales. CFFO divided by net sales was the only ratio that gave a
somewhat constant percent, omitting year 2005. Therefore, the average of
CFFO/sales was used to forecast out the cash flows from operations. The growth
rate of plant, property, and equipment (PP&E) was used to grow the investing
activities over the next ten years. The growth for PP&E was used to forecast
investing activities because investing activities are what your company spends
money on for the firm. In other words, it is the tangible assets that the company
purchases to keep production going. In this case, a 6% growth rate was used for
forecasting the investing activities. The growth rate is low because Motorola has
been downsizing their PP&E over the past few years and therefore, reducing their
investing activities.
Forecasting Quarterly Information
Motorola does not have seasonal sales, but there is a small slowdown after
Christmas, the first quarter. In order to forecast out the first quarter of 2007,
there were a few steps involved. First, the first quarter information was taken as
a percent of the end of the year balance for all accounts on the balance sheet and
income statement. For example, the quarter one for 2002 was divided by the end
of the year balance for 2002. This was done for all five years. Then, an average
of four years was taken for all accounts. Year 2001 was omitted because of the
economic downfall at the end of 2001. Finally, the average of the accounts was
applied to the forecasted amount for the year. For example, quarter one of
2007’s cash account was found by multiplying the end of the year forecasted
amount by the average found for the cash account.
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Accuracy of the Forecasting
Motorola’s 10-K for 2006 came out in March of 2007. As you can see, we
have a forecasted out 2006 and the actual results for 2006. On the chart, most of
the items forecasted out were lower than what actually happened in 2006.
However, the net income forecasted for 2006 was higher than 2006’s actually net
income due to higher interest expense and lower operating income. Overall, most
of the forecast were within 10%.
Method of Comparables: 2006: Trailing Price/Earnings: In calculating the trailing price/earnings ratio, we simply took the current
stock price and divided by last year’s earnings per share. The results are as
follows:
MOT 12.30 Industry 16.10
NOK 19.29 MOT EPS x 1.46 ERIC 16.95 Estimated
Share Price $23.51
After multiplying the industry average by Motorola’s EPS for 2006, we arrived at
an estimated share price. The estimated price per share implies that Motorola is
undervalued by $1.25.
EPS BPS DPS PPS MOT 1.46 6.164 0.05 22.26 NOK 1.31 4.26 0.448 20.06 ERIC 1.65 11.2 0.58 35.08
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Forward Price/Earnings: The projected EPS for Motorola, Nokia, and Ericsson are 1.14, 1.42, and
2.44 respectively. We therefore divided our current price by these projected
values, and came to the following conclusions:
MOT 19.53 Industry 16.01
NOK 14.13 MOT EPS x 1.46 ERIC 14.38 Estimated
Share Price $23.37
We again came across an industry average that we multiplied by Motorola’s EPS,
and were lead to the result that Motorola is undervalued by $1.11.
Market/Book Ratio: The market/book ratio was calculated by taking the price divided by the
book value per share for each company accordingly. The chart below determines
the estimated share price when using the market/book ratio.
MOT 3.61 Industry 3.82
NOK 4.71 MOT BPS x 6.164 ERIC 3.13 Estimated
Share Price $23.55 The estimated share price is $23.55, and according to the market/book ratio,
Motorola is undervalued.
Dividend/Price Ratio: The dividend/price ratio is calculated by simply taking the average
dividends of all three companies in the industry. By dividing Motorola’s DPS by
the industry average we come up with an estimated share price. The outcome is
as follows:
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MOT .002 Industry .007 NOK .002 MOT DPS .05 ERIC .017 Estimated
Share Price $7.15
We can see from the above chart that Motorola’s $7.15 estimated share price
results in a current overvalued share price for the company.
P.E.G Ratio: The P.E.G ratio was calculated by taking the sum of the industry’s
companies’ P/E ratio divided by 1- EPS growth rate. Motorola’s EPS growth rate
was -69.7% for 2006. The following chart outlines the calculations to end with an
estimated share price for Motorola:
MOT 8.98 Industry
NOK 18.52 Growth Rate 17.65 ERIC 25.46 MOT EPS x 1.46
Estimated Share Price $25.77
According to the estimated share price, the P.E.G ratio calculated Motorola to be
currently undervalued by $3.51.
Price/EBITDA Ratio:
MOT 10.70 Industry 8.22 NOK 9.65 MOT ERIC 4.32 P/EBITDA x10.70 Estimated
Share Price $87.99
The above ratio is calculated by taking each company’s EBITDA and
dividing it by the total shares outstanding. The price is then divided by the
calculated EBITDA per share. Taking the industry average and multiplying it by
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Motorola’s Price/EBITDA ratio results in Motorola’s estimated share price, making
the company’s current share undervalued.
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Valuation Analysis Cost of Capital:
The cost of capital is the return that investors expect to receive when they
invest in a company. Determining a company’s cost of capital (Ke) involves
several steps. To properly find the Ke, you have to run a regression of the market
risk premium for 72, 60, 48, 36, and 24 month stock prices and the risk free rates
for the 3 month, 1 year, 5 year, 7 year, and 10 year treasury rates. The
regression produces a Beta (B), which is a measure of how risky your firm is. The
higher the Beta is, the more risky your firm. The regression also produced an
adjusted r squared. The adjusted r square explains how much of the Beta is
associated with systematic risk, which is the market risk. The higher the adjusted
r squared the more that the risk is due to the industry and not just to the firm.
The Beta is then used in the CAPM formula to calculate the Ke. The following
table shows the beta and adjusted r squared that the regression produced.
60 Month Treasury Yield Beta Adjusted R2
3 Month 1.01 0.133 1 Year 1.00 0.132 5 Year 0.99 0.130 7 Year 0.99 0.130
10 Year 0.99 0.129
*All treasury rates were found from http://research.stlouisfed.org/fred2/
*S&P 500 monthly returns, Motorola monthly returns, and Motorola’s dividends were from
finance.yahoo.com
The 3 month treasury taken for 60 months back had the highest adjusted r
squared, which the industry risk explains the highest portion of our Beta. In this
case, only 13.3% of the risk associated with Motorola is from the industry as a
whole. This makes Motorola alone relatively risky. This Beta of 1.01 produced a
cost of capital of 11.3%. This Beta is smaller than the Beta of 1.39 that
Yahoo.finance.com gave the company.
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Now that a Beta was found for our company, a cost of capital can be
computed by using the CAPM model. In order to find the cost of capital, we not
only need the Beta, we need a market risk premium and a risk free rate. The
current risk free rate (Rf) is 5.25% and was used in this equation. The market
risk premium (MRP) used for Motorola is 6%. In recent years, the acceptable
market risk premium is between 4 and 6 percent. This is in contrast to the market
risk premium of 8-11% that spans over the past thirty years. Since Motorola is a
company that is constantly evolving and the electronic industry is still relatively
new, the more recent market risk premium range was chosen. The higher market
risk premium was chosen in figuring cost of capital because the entire
telecommunications industry is very unstable. Since the whole industry is
unstable, stockholders will be rewarded for their risk in any telecommunication
firm that they invest in. Therefore, in choosing a higher market risk premium, the
cost of equity is higher for Motorola, which means a higher return for investors.
The formula to find the cost of capital is:
Ke= Rf + B*(MRP)
Ke= 5.25% + 1.01(6%)
Ke= 11.3%
Cost of Debt:
To accurately find the cost of debt, an average of the interest rates for
Motorola had to be taken. Motorola listed their interest rates for their current and
long-term liabilities in their 2006 10K. The following table shows the values for
finding the cost of debt.
Long Term Notes
Rate Debt (in millions) Weight Weight*Rate
7.60% 118 0.0300 0.0023 4.61% 1205 0.3065 0.0141 6.50% 114 0.0290 0.0019 5.80% 84 0.0214 0.0012 7.63% 525 0.1336 0.0102 8.00% 599 0.1524 0.0122
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6.50% 397 0.1010 0.0066 7.50% 398 0.1012 0.0076 6.50% 297 0.0756 0.0049 5.22% 194 0.0494 0.0026 3931 6.35%
Short Term Debt 5.10% 300 0.1850 0.0094 5.80% 1322 0.8150 0.0473 1622 5.67% Average Cost of Debt 6.01%
For both types of debt, a weight was found. This weight is a percentage of how
much that particular debt makes up the overall long term debt. For example, the
$118 million is only 3% of the long-term debt. The same method was applied for
finding the weights for the short term debt. The weight of each aspect of debt
was multiplied by its relative interest rate. These values were added up to get an
average debt for long term and short term. Then, to get one cost of debt, the
short term and long term debt rates were averaged. Therefore, Motorola’s
average cost of debt is 6.01%.
Weighted Average Cost of Capital:
The WACC is a measure of how much the firm returns with respect to debt
and equity. There are very few firms who are all equity because the cost of
starting a new business and running a successful business is costly. However,
there are benefits to having debt. There are tax breaks that come with having
debt and debt allows a companies to acquire funds for new projects or new
research. For Motorola, the telecommunications industry is very costly because
technology becomes obsolete very quickly. Since a large portion of Motorola is
financed by debt, an average needed to be taken of the cost of debt and the cost
of equity in relation to the value of the firm. The formula for the weighted
average cost of capital is:
WACC= [(VE/VF)*Ke] + [(VD/VF)*Kd] (1-Tax rate)
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Using this formula, we found Motorola’s WACC using information from their 2006
10K.
Value of the Firm= 38593
Value of Equity= 17142
Value of Debt= 21451
*Cost of Debt= 6.01%
*Cost of Equity= 11.3%
Tax Rate= 35%
*these are the computed numbers found for Motorola
WACC= [(17142/38593)*11.3%] + [(21451/38593)*6.01%] (1-35%)
WACC= 7.11%
The formula above shows the weighted average cost of capital after tax.
There is a WAAC before tax but it is more appropriate to use an after tax WACC
when dealing with large corporations who pay large amounts of taxes. This
value will be used later when valuing the firm. The WACC formula weights “the
costs of debt and equity according to their respective market values” (Palepu, p.
8-2) The cost of capital and cost of debt weights are a percentage of total capital
earned by the firm.
Intrinsic Valuation
To properly value our company, we used four valuation models:
discounted dividends, free cash flows, residual income, and abnormal earnings
growth. These models were run to see which gives the best explanatory power
of the stock price. In a sense, these models were run to see which comes
closest to the observed stock price. These models can tell a great deal about a
company. All four models use forecasted earnings to find the value of the
current stock price. This is done to see how profitable this company will be in
the future. If the company is projecting high returns in future years, its current
stock price might be undervalued. However, these models can also signal
trouble if the company’s intrinsic value is found to be continuously less than the
stock price. If a model does a poor job of explaining the stock price, it could
lead to bad investments or decisions not to invest. To test the soundness of
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each model, a sensitivity analysis was taken to see how much the intrinsic value
per share deviates with different growth rates and costs of capital or WACC.
It is important to run all four types of models against a company to get
the best idea of how to value this company. Each model uses its own growth
rate because the dividends do not grow as much as the cash flows or the
residual income. The full assessment for each valuation model can be found in
appendices.
Discounted Dividends Model
The dividend discount model is one of the basic models in financing.
However, the model can give poor explanations for the stock price. This model
would tell an investor not to invest or tell an investor to sell their stock in
Motorola because it is overvalued. This model uses the cost of equity because
the shareholder’s are the ones who get the dividends. This model does a poor
job of explaining the value of a company if the company pays low dividends, like
Motorola. Dividends do a poor job of explaining the stock price because the
dividends are relatively “sticky” over the years when the stock price of a
company changes daily. Therefore, the left side of the equation (the stock price)
is very volatile while the right side of the equation (the dividends) changes every
few years. Therefore, the growth rate for dividends is low because they change
very little over the course of a few years.
In the Dividend Discount Model, the stream of dividends was taken out to
10 years and then calculated to the present value. After the ten year stream, a
perpetuity was taken to see how much the dividends pay after ten years until
time infinity. This perpetuity was found by dividing the terminal value of the
dividends by the cost of capital minus the growth rate. This value was in year
ten dollars so the present value of that perpetuity had to be taken.
g 0 0.01 0.03 0.05
0.07 1.59 1.64 1.81 2.32 0.09 1.39 1.41 1.48 1.62 0.11 1.24 1.25 1.28 1.34 0.13 1.12 1.13 1.14 1.17
Ke
0.15 1.02 1.03 1.04 1.05
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*the highlighted value is the intrinsic value used for Motorola
The chart above is a sensitivity analysis. This analysis shows the different
intrinsic values using a different growth rate and a different cost of capital. As
seen in the chart, the intrinsic value changes by only a few cents when you
change the growth rate or the cost of capital. This analysis shows how reliable
this model is in determining the value per share. Despite which cost of capital
and what growth rate is used, the value of Motorola’s share is still considerably
overpriced, according to this model.
Free Cash Flows Model
This model uses the weighted average cost of capital (WACC). The free
cash flow model uses the forecasted free cash flows from operations (CFFO) to
value the firm. As seen before, the forecasting of our CFFO was difficult and had
to be based off of sales. Forecasting has error so the problem with this model is
that you are using error riddled CFFO to value your firm at the current.
Therefore, if your CFFO is forecasted too high, you could buy more stock
because the model said to when you should sell it.
g 0 0.06 0.08 0.1
0.03 18.65 32.57 49.59 134.66 0.05 16.11 27.81 42.12 113.67
0.0711 13.87 23.66 35.62 95.44 0.09 12.18 20.55 30.77 81.88
Wacc
0.11 10.67 17.77 26.45 69.84 *the highlighted value is the intrinsic value used for Motorola
This chart is the sensitivity analysis for the Discounted Free Cash Flows
Model. As seen in the chart, the slightest change to the growth rate or the cost
of capital causes a huge change to the intrinsic value per share. Therefore, if
too high of a growth rate were used and too low of a WACC was used, the price
for Motorola’s stock would be considered extremely over valued and an investor
would want to sell this stock immediately. However, if just the opposite were
true for the Ke and growth rate, an investor would consider Motorola’s stock
valued too low and they would invest more in the company.
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Residual Income Model
This model is derived from the dividend discount model so it is grounded
in financial theory. The model requires a company to beat a benchmark in order
for a company to create value. This is key in valuing a firm because the model
keeps the value number from suddenly jumping. The benchmark is the
beginning book value of equity times the cost of equity. This benchmark is what
the shareholders are expecting to receive at the end of the year. Therefore, if a
company beats their benchmark, they have to created value for their
shareholders. Then, for the next year, shareholders will have a higher
benchmark for the company because the beginning book value of equity was
higher. It is naïve to think that a company can continuously beat their new
benchmarks. Therefore, when computing the residual income perpetuity, a
negative growth rate was used.
g -0.03 0 0.01 0.03 0.05
0.07 16.21 17.31 18.25 21.55 31.43 0.09 11.72 11.67 11.93 12.71 14.27
Ke 0.11 8.72 8.46 8.52 8.68 8.95 0.13 6.94 6.4 6.4 6.39 6.39 0.15 5.53 4.95 4.94 4.89 4.83
*the highlighted value is the intrinsic value used for Motorola
The residual income sensitivity analysis chart is shown above. In this
chart, the values are relatively stable when the same cost of capital is used
against different growth rates. This coincides with the fact that it is difficult to
continuously beat your normal income so a growth rate is almost irrelevant when
determining the intrinsic value per share using this model. As with all other
models, a lower denominator, in this case the cost of capital generates a higher
intrinsic value per share. At the cost of capital of 11%, Motorola does create
value for their shareholders. However, according to this model, the shareholders
are paying more for a stock that should be price much lower.
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Abnormal Earnings Growth Model
In order for a firm to increase its market value, it must be able to
generate abnormal earnings (Palepu, p.7-3). This model is a better way to value
a company that does not pay dividends. Since cash flows usually generate a
high intrinsic value because a large growth rate can be used for the perpetuity.
The residual income and discounted dividend models use the dividends a
company pays to help value a firm. However, when a firm does not pay
dividends to their shareholders, these valuations become skewed. Therefore, the
AEG model does a better job of explaining a companies stock price if they do not
play dividends.
g -0.05 -0.03 0 0.03 0.05 0.07 15.68 15.62 15.52 15.43 15.37 0.09 14.19 14.13 14.04 13.94 13.88
Ke 0.11 12.9 12.84 12.75 12.65 12.59 0.13 11.78 11.72 11.62 11.53 11.47 0.15 10.8 10.74 10.64 10.55 10.48
Credit Worthiness Analysis
The Altman Z-Score is used in determining the credit risk of a company for
the lender. When the score below 1.8 this means the company has a high risk of
bankruptcy and it is possible that the lender will not get their payments,
therefore charging the company with a higher interest premium. A company will
want their z-score above 2.7 this is a good number the lender goes by in
showing that you are a credit worthy company and that you have a low
possibility of going bankrupt. When a company’s score is above 2.7 you will also
get a much lower interest rate which is desirable. The z-score is a measure
which weighs all companies equally using the multipliers in front of the ratios.
The z-score can be defined as:
Z-score= 1.2(working capital/total assets) +1.4(retained earnings/total
assets) +3.3(earnings before interest and taxes) +.6(market value of
equity/book value of liabilities) +1(sales/total assets)
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The ratios with the biggest multipliers in front of them are the most
important for example, earnings before interest and taxes/total assets has a 3.3
in front which means it is weighted the most since it is current earnings that are
being accounted for by total assets this is more important to lenders.
Motorola has a z-score of 2.42 in 2002 and this decreased to 2.18 in 2003,
which means they became slightly more risky. This low z-score is probably due
to a low price per share value in the two years and a much lower amount of
sales compared to 2004-2006. Lenders would have lent to them in those years
but they would have had a higher interest rate than a company with a higher z-
score.
In years 2004-2006, the z-score was above 3 which means that they will
most likely not go bankrupt. This high z-score could be due to Motorola having
operating leases. When a company has operating leases it is a way to lower
your assets on the books which will have an affect on the ratios that have a
denominator of total assets making them larger. Therefore, this increase in
these ratios will make the z-score of the company higher and make them more
credit worthy even thought they are just hiding behind operating leases.
Lenders are getting better at analyzing this manipulation and they are watching
for companies with operating leases. Since Motorola had an increase in rent
expense for 2005 and 2006. This could be affecting the z-score for those two
years since they are in the 3.8-9 range which is very high. In previous
calculations of capitalizing Motorola’s leases this change from operating leases to
capitalizing leases would not change the books that much so it would not have a
huge affect in the ratios but some. Overall, Motorola is a very credit worthy
company based on the past 3 years and they are most likely to get low interest
rates from lenders and will most likely not go bankrupt any time soon.
Motorola's Z-Score 2002 2003 2004 2005 2006
Working Capital/Total Assets 0.24
0.26
0.34
0.43
0.40
Retained Earnings/Total Assets 0.08
0.10
0.06
0.17
0.24
Earnings before interest and taxes/Total Assets
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0.12 0.05 0.11 0.19 0.13
Market Value of Equity/Book Value of Liabilities 1.45
1.40
2.31
2.48
2.54
Sales/Total Assets 0.75
0.72
1.01
1.03
1.11
Z-Score 2.42
2.18
3.26
3.90
3.87
Valuation Conclusion:
After running all four valuation models, we conclusively say that Motorola
is overvalued. The Dividend Discount model returned to lowest value for
Motorola with only a $1.28 intrinsic value. Despite the fact that Free Cash Flows
model said Motorola was undervalued, we still feel that Motorola is the opposite.
Free Cash Flows was dependant on the forecasting on the cash flow from
operations, which was unstable over the past five years. Therefore, cash from
operations had to be based off of Motorola’s sales. Residual Income model
returned an intrinsic value that said Motorola was overvalued, as well as the
Abnormal Earnings growth model.
The Residual Income model has the highest degree of explanation when
finding the intrinsic value of a firm. Therefore, we used this value of $8.72 as the
intrinsic value of Motorola. According to Yahoo!, Motorola has a stock price of
$17.56 as of April 1, 2007. We feel that Motorola is $8.84 overvalued and we
recommend investors to sell.
77
78
Appendix 1- Screening Ratios
Revenue Diagnostics Motorola 2002 2003 2004 2005 2006Net Sales/ Cash from Sales 1.01 1.01 1.02 1.04 1.00Net Sales/ Accounts Receivable 5.28 6.06 6.92 6.38 5.71Net Sales/ Inventory 8.16 11.03 12.30 14.61 13.56Net Sales/ Warranty Liability 72.74 64.50 62.65 73.54 80.90 Nokia 2002 2003 2004 2005 2006Net Sales/ Cash from Sales N/A N/A N/A N/A N/A Net Sales/ Accounts Receivable 5.57 5.63 6.68 6.40 6.98Net Sales/ Inventory 23.51 25.20 22.43 20.50 26.46Net Sales/ Warranty Liability 254.37 187.61 248.03 226.43 306.87 Ericsson 2002 2003 2004 2005 2006Net Sales/ Cash from Sales 1.07 1.54 0.99 0.96 1.00Net Sales/ Accounts Receivable 3.99 0.37 4.04 3.68 3.48Net Sales/ Inventory 10.86 1.07 9.42 7.90 8.28Net Sales/ Warranty Liability N/A N/A N/A N/A N/A
Expense Diagnostics Motorola 2002 2003 2004 2005 2006Asset Turnover 0.75 0.72 1.01 1.03 1.11CFFO/OI 0.63 1.56 0.98 0.98 1.07CFFO/NOA 0.19 0.81 1.31 2.03 1.54Pension Expense/SG&A 0.04 0.08 0.08 0.07 0.06 Nokia 2002 2003 2004 2005 2006Asset Turnover 1.29 1.23 1.29 1.53 1.82CFFO/OI 0.72 0.83 1.00 1.13 0.82CFFO/NOA 1.85 2.65 2.83 3.31 2.80Pension Expense/SG&A 0.07 0.05 0.09 0.09 0.09 Ericsson 2002 2003 2004 2005 2006Asset Turnover 0.70 0.06 0.72 0.73 0.83CFFO/OI 0.47 0.79 0.68 0.50 0.52CFFO/NOA 0.01 0.07 0.09 0.04 2.35Pension Expense/SG&A 0.37 0.34 0.62 0.19 0.02
79
Appendix 2- Financial Ratios
Current Ratio Operating Profit Margin 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 MOT 1.75 1.90 1.99 2.23 2.01 MOT 17.04% 14.19% 11.86% 10.47% 10.50% NOK 2.09 2.43 2.45 1.96 1.83 NOK 10.76% 11.42% 10.17% 8.66% 8.06% ERIC 2.24 2.41 2.99 1.91 2.16 ERIC 20.56% 203.42% 12.31% 11.07% 12.05% Industry 2.03 2.25 2.48 2.03 2.00 Industry 16.12% 76.34% 11.44% 10.07% 10.20%
Quick Asset Ratio Net Profit Margin 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 MOT 1.12 1.24 0.70 0.76 1.50 MOT -10.61% 3.86% 4.89% 12.43% 8.54% NOK 0.82 0.77 0.69 0.71 0.73 NOK 12.00% 13.91% 11.42% 10.48% 10.47% ERIC 1.22 1.57 1.58 1.22 0.73 ERIC -13.04% -92.38% 14.42% 16.11% 14.87% Industry 1.05 1.19 0.99 0.90 0.99 Industry -3.88% -24.87% 10.24% 13.00% 11.29%
Accounts Receivable Turnover Asset Turnover 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 MOT 5.28 6.06 6.92 6.38 5.71 MOT 0.75 0.72 1.01 1.03 1.11 NOK 5.57 5.63 6.68 6.40 6.98 NOK 1.29 1.23 1.29 1.53 1.82 ERIC 3.9 3.9 3.9 3.9 3.9 ERIC 0.70 0.06 0.72 0.73 0.83 Industry 4.92 5.20 5.83 5.56 5.53 Industry 0.91 0.67 1.01 1.10 1.25
Days Until Collection of A/R Return on Assets 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 MOT 69.14 60.25 52.73 57.25 63.92 MOT -7.44% 2.86% 4.78% 14.82% 10.27% NOK 65.48 64.82 54.65 57.07 52.26 NOK 18.92% 21.04% 15.19% 13.72% 21.53% ERIC 91.49 991.51 90.28 99.15 104.85 ERIC -11.45% -6.29% 11.25% 11.23% 14.67% Industry 75.37 372.19 65.89 71.16 73.68 Industry 1.43% 5.71% 6.72% 11.19% 11.19%
Inventory Turnover Return on Equity 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 MOT 5.49 7.46 8.24 9.94 9.54 MOT -18.15% 7.95% 12.07% 34.34% 21.96% NOK 14.31 14.75 13.90 13.31 17.85 NOK 31.42% 36.36% 29.55% 29.11% 38.36% ERIC 7.35 7.20 5.06 4.29 4.87 ERIC -3.19% -2.05% 4.72% 3.99% 5.05% Industry 9.05 9.80 9.06 9.18 10.75 Industry 0.55% 16.34% 12.51% 21.51% 21.51%
Days Supply of Inventory Debt to Equity Ratio 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 MOT 66.53 48.95 44.32 36.72 38.28 MOT 1.77 1.53 1.32 1.14 1.25 NOK 25.50 24.75 26.27 27.41 20.45 NOK 0.61 0.56 0.57 0.79 0.88 ERIC 49.66 50.72 72.13 85.12 75.00 ERIC 1.83 2.02 1.37 1.04 0.78 Industry 47.23 41.48 47.57 49.75 44.57 Industry 1.41 1.37 1.09 0.99 0.97
Working Capital Turnover Times Interest Earned 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 MOT 3.20 2.73 2.98 2.40 2.76 MOT 5.11 4.33 15.74 14.45 0.00 NOK 3.27 2.50 2.54 3.68 4.88 NOK 111.22 200.48 196.85 257.66 0.00 ERIC 1.84 0.15 1.45 2.01 2.19 ERIC N/A N/A N/A N/A N/A Industry 2.77 1.79 2.32 2.70 3.28 Industry 58.16 102.40 106.29 136.06 0.00
Gross Profit Margin Debt Service Margin 2002 2003 2004 2005 2006 2002 2003 2004 2005 2006 MOT 32.79% 32.40% 33.06% 31.97% 29.68% MOT 0.71 2.22 4.28 10.28 1.93 NOK 39.11% 41.48% 38.04% 35.04% 32.54% NOK N/A N/A N/A N/A N/A ERIC 28.50% 330.87% 46.30% 41.79% 41.23% ERIC N/A N/A N/A N/A N/A Industry 33.47% 134.92% 39.13% 36.27% 34.48%
80
Appendix 3- Common Size Financial Statements
Income Statement 2001 2002 2003 2004 2005 2006 Average Net Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% Cost of Goods Sold 75.84% 67.21% 67.60% 66.94% 68.03% 70.32% 69.32% Gross Profit Margin 24.16% 32.79% 32.40% 33.06% 31.97% 29.68% 31.98% Research and Development 14.02% 11.84% 12.87% 10.89% 9.99% 9.58% 11.53% Sales, General & Administrative 16.14% 17.04% 14.19% 11.86% 10.47% 10.50% 10.95% Interest Income (Expense) 1.35% 1.52% 1.27% 0.64% 0.19% 0.76% 0.95% Income Before Tax 9.94% 17.40% 10.75% Operating Income 19.03% 7.74% 5.50% 9.55% 12.50% 9.54% 10.64% Net Income -12.91% -10.61% 3.86% 4.89% 12.43% 8.54% 10.48%
Balance Sheet 2001 2002 2003 2004 2005 2006 AVG
Assets
Cash 23.41% 24.75% 36.61% 8.55% 10.59% 8.32% 9.15%
Sigma Funds N/L N/L N/L 23.17% 30.48% 31.62% 28.43%
Short Term Investments N/L N/L N/L 0.46% 0.40% 0.58% 0.43%
Receivables 17.64% 16.88% 17.96% 13.60% 16.21% 19.46% 16.82%
Inventory 10.61% 10.91% 9.87% 7.65% 7.07% 8.19% 8.74%
Deferred Income Taxes 10.13% 20.81% 19.44% 11.70% 6.70% 4.49%
Other Current Assets 3.91% 3.44% 4.49% 5.39% 6.71% 7.60% 5.53%
Current Assets 65.70% 76.78% 88.38% 70.53% 78.18% 80.26% 75.91%
Net Property Plant & Equipment 34.30% 23.22% 11.62% 7.01% 6.37% 5.87% 6.42%
Investments N/L N/L N/L 9.74% 4.64% 2.32% 5.57%
Deferred Income Taxes N/L N/L N/L 7.07% 3.49% 3.43%
Other Assets N/L N/L N/L 5.65% 7.32% 8.11% 7.03%
Total Long Term Assets 34.30% 23.22% 11.62% 29.47% 21.82% 45.65% 27.14%
Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Liabilities
Notes Payable N/L N/L N/L 4.08% 2.36% 7.89% 4.78%
Accounts Payable 12.35% 11.39% 12.70% 18.93% 23.22% 23.57% 17.96%
Income Tax Expense N/L N/L N/L 37.27% 40.23% 40.45%
Total Current Liabilities 12.35% 11.39% 12.70% 60.28% 65.81% 71.91% 44.42%
Common Equity N/L 34.89% 36.25% N/L N/L N/L
Long Term Debt 42.48% 36.10% 34.47% 26.04% 20.06% 12.61% 25.86%
Other Liabilities N/L N/L N/L 13.68% 14.13% 15.49% 14.43%
Total Long Term Liabilities N/L 44.28% 38.96% 30.12% 22.42% N/L 33.95%
Total Liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Shareholder's Equity
Stock N/L N/L N/L 55.08% 45.03% 41.98% 47.37%
Additional Paid-In-Capital N/L N/L N/L 32.41% 28.14% 14.64% 25.06%
Retained Earnings 39.69% 22.97% 24.45% 12.92% 35.37% 53.00% 29.74%
Total Stockholders Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
TOTAL Asset Growth -0.0672 0.0287 -0.0351 0.1529 0.0826 11.77%
81
Statement of Cash Flows 2001 2002 2003 2004 2005 2006 Average
Operating
Net Earnings -
199.24% -
185.59% 44.85% 49.97% 99.41% 104.63% 74.72%
Loss from Discontinued Operations 0.00% 0.00% 1.76% -18.49% 1.28% 11.43% -0.67%
Earnings from Continuing Operations 0.00% 0.00% 46.61% 68.46% 98.13% 93.20% 51.07%
Depreciation and Amortization 129.15% 157.43% 41.08% 21.49% 13.31% 15.95% 63.07%
Charges for Reorganization of Business 242.21% 196.19% 7.94% 4.92% 4.54% 0.00% 75.97%
Gains on Sales of Investments and Business -97.72% -7.17% -27.07% -15.00% -40.41% -1.17% -31.43%
Deferred Income Taxes -
115.03% -
117.25% -8.04% 14.87% 21.72% 23.95% -29.96%
Accounts Receivable 123.73% 11.58% -7.03% -17.97% -28.30% -50.73% 5.21%
Inventories 93.02% -7.62% -1.71% -13.01% -0.41% -20.52% 8.29%
Other Current Assets 12.60% 2.91% 5.47% -25.44% -15.66% -11.09% -5.20%
Accounts Payable and Accrued Liabilities -
153.34% -73.19% 28.93% 60.01% 52.23% 47.27% -6.35%
Other Assets and Liabilities 1.27% 18.82% 13.86% -3.42% -8.43% 6.14% 4.71%
Net Cash from Operating Act. 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
CFFO/Net Income -50.19% -53.88% 222.96% 200.13% 100.59% 95.57% 98.26%
CFFO/Operating Income 34.05% 73.86% 156.40% 102.47% 100.00% 85.51% 98.34%
CFFO/Sales 6.48% 5.72% 8.60% 9.79% 12.50% 8.16% 8.37%
82
Appendix 4- Valuation Models
Dividend Discount Model Observed Price Per Share 17.56Initial Cost of Equity 0.11Growth Rate for Dividends 0.01
g 0 0.01 0.03 0.05
0.07 1.59 1.64 1.81 2.32 0.09 1.39 1.41 1.48 1.62 0.11 1.24 1.25 1.28 1.34 0.13 1.12 1.13 1.14 1.17
Ke
0.15 1.02 1.03 1.04 1.05
1 2 3 4 5 6 7 8 9 10
Discounted Dividends 4/1/07 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 EPS $1.46 $1.65 $1.77 $1.90 $2.04 $2.19 $2.35 $2.53 $2.72 $2.92 $3.14 $3.36
DPS 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20
BPS 17.56
PV Factor 0.9009 0.8116 0.7312 0.6587 0.5935 0.5346 0.4817 0.4339 0.3909 0.3522
PV of Dividends 0.1802 0.1623 0.1462 0.1317 0.1187 0.1069 0.0963 0.0868 0.0782 0.0704 Total PV of Annual Discounted Dividends 1.107 Continuing Terminal Value Perpetuity 2.00 PV of Terminal Value Perpetuity 0.1409
Estimated Value per Share 1.248
Observed Value 17.56
Difference 16.31
83
Free Cash Flows Model Observed Price Per Share 17.56Growth Rate for Free Cash Flows 0.08Outstanding Shares as of March 30, 2007 (in millions) 2390Cost of Debt 0.0601WACC 0.0711
g 0 0.06 0.08 0.1
0.03 18.65 32.57 49.59 134.66 0.05 16.11 27.81 42.12 113.67
0.0711 13.87 23.66 35.62 95.44 0.09 12.18 20.55 30.77 81.88
Wacc
0.11 10.67 17.77 26.45 69.84
Free Cash Flows 4/1/07 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Cash From Operations $3,499 3791.94 4109.40 4453.44 4826.28 5230.34 5668.23 6142.77 6657.05 7214.38 7818.37 8472.93 Cash Provided (Used) by Investing Activities $1,048 2412.49 2567.31 2732.07 2907.41 3093.99 3292.55 3503.85 3728.72 3968.01 4222.66 4493.66 Free Cash Flow (to firm) 1379.45 1542.09 1721.37 1918.88 2136.35 2375.68 2638.92 2928.33 3246.37 3595.71 3979.27 Discount Rate (WACC) 0.0711 0.9336 0.8716 0.8138 0.7598 0.7093 0.6622 0.6183 0.5772 0.5389 0.5032 Present Value of Free Cash Flows 1287.88 1344.15 1400.83 1457.90 1515.38 1573.28 1631.61 1690.36 1749.55 1809.19 Total Present Value of Annual Cash Flows 13650.9 Continuing (Terminal) Value 132642 Present Value of Continuing (Terminal) Value
71484.52
Value of Firm 85135.4
7 Intrinsic Value per Share 35.62 Observed Price 17.56 Difference (18.06)
84
Residual Income Model
Observed Price Per Share 17.56Initial Cost of Equity 0.11Growth Rate for Residual Income -0.03Outstanding Shares as of March 30, 2007 (in millions) 2390
g -0.03 0 0.01 0.03 0.05
0.07 16.21 17.31 18.25 21.55 31.43 0.09 11.72 11.67 11.93 12.71 14.27
Ke 0.11 8.72 8.46 8.52 8.68 8.95 0.13 6.94 6.4 6.4 6.39 6.39 0.15 5.53 4.95 4.94 4.89 4.83
Residual Income 4/1/07 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Net Income (in millions) $2,745.75 $3,038.02 $3,361.41 $3,719.22 $4,115.11 $4,553.15 $5,037.81 $5,574.07 $6,167.40 $6,823.89 $7,550.27 Earnings per Share $1.65 $1.77 $1.90 $2.04 $2.19 $2.35 $2.53 $2.72 $2.92 $3.14 $3.36 Dividends Paid Out (in millions) $478.00 $478.00 $478.00 $478.00 $478.00 $478.00 $478.00 $478.00 $478.00 $478.00 $478.00 Dividends per Share 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.05 Book Value per Share 3.00 $4.45 $6.01 $7.71 $9.55 $11.54 $13.70 $16.03 $18.55 $21.26 $24.20 Benchmark $0.49 $0.66 $0.85 $1.05 $1.27 $1.51 $1.76 $2.04 $2.34 $2.66 Creating Value (Destroying Value) $1.16 $1.11 $1.05 $0.99 $0.92 $0.85 $0.77 $0.68 $0.58 $0.47 Present Value Factor 0.9009 0.8116 0.7312 0.6587 0.5935 0.5346 0.4817 0.4339 0.3909 0.3522 Present Value of Residual income 1.0420 0.8979 0.7683 0.6517 0.5471 0.4532 0.3691 0.2939 0.2267 0.1669 Total Present Value of Residual Income 5.25 Continuing (Terminal) Value 1.19 Present Value of Continuing (Terminal) Value 0.47 Intrinsic Value per Share 8.72 Observed Price 17.56 Difference 8.84
85
Abnormal Earnings Growth Model
Observed Price Per Share 17.56Initial Cost of Equity 0.11Growth Rate for Abnormal Earnings Growth -0.05Outstanding Shares as of March 30, 2007 (in millions) 2390
-0.05 -0.03 0 0.03 0.05 0.07 15.68 15.62 15.52 15.43 15.37 0.09 14.19 14.13 14.04 13.94 13.88
Ke 0.11 12.9 12.84 12.75 12.65 12.59 0.13 11.78 11.72 11.62 11.53 11.47 0.15 10.8 10.74 10.64 10.55 10.48
Abnormal Earnings Growth 4/1/07 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 EPS $1.65 $1.77 $1.90 $2.04 $2.19 $2.35 $2.53 $2.72 $2.92 $3.14 $3.36 DPS 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.2 DPS Invested 0.022 0.022 0.022 0.022 0.022 0.022 0.022 0.022 0.022 0.022 Cumulative Dividend Earnings $1.79 $1.92 $2.06 $2.21 $2.38 $2.55 $2.74 $2.94 $3.16 $3.38 Normal Earnings $1.96 $2.11 $2.26 $2.43 $2.61 $2.81 $3.02 $3.24 $3.48 $3.72 Abnormal Earnings Growth ($0.17) ($0.19) ($0.20) ($0.22) ($0.24) ($0.26) ($0.28) ($0.30) ($0.32) ($0.35) PV Factor 0.9009 0.8116 0.7312 0.6587 0.5935 0.5346 0.4817 0.4339 0.3909 PV of AEG ($0.16) ($0.15) ($0.15) ($0.14) ($0.14) ($0.14) ($0.13) ($0.13) ($0.13) Core EPS $1.65 Total PV of AEG ($1.27) PV of Terminal Value ($0.15) ($0.15) Total Average EPS Perpetuity ($1.42) Capitalization Rate 0.11 Intrinsic Value Per Share $12.90 Observed Share Price 17.56 Difference $4.66
86
Appendix 5- Weighted Average Cost of Capital and Cost of Debt Computations
WACC= [(VE/VF)*Ke] + [(VD/VF)*Kd] (1-Tax rate)
Long Term Notes
Rate Debt (in millions) Weight Weight*Rate
7.60% 118 0.0300 0.0023 Value of Debt 214514.61% 1205 0.3065 0.0141 Value of Equity 171426.50% 114 0.0290 0.0019 Value of Firm 385935.80% 84 0.0214 0.0012 Ke 11.30%7.63% 525 0.1336 0.0102 Kd 5.78%8.00% 599 0.1524 0.0122 Tax Rate 35%6.50% 397 0.1010 0.0066 7.50% 398 0.1012 0.0076 6.50% 297 0.0756 0.0049 WACC 7.11%5.22% 194 0.0494 0.0026 3931 6.35%
Short Term Debt 5.10% 300 0.1850 0.0094 5.80% 1322 0.8150 0.0473 1622 5.67% Average Cost of Debt 6.01%
87
References
www.motorola.com
www.nokia.com
www.ericsson.com
research.stlouisfed.org/fred2/
finance.yahoo.com
finance.google.com
www.edgarscan.pwcglobal.com
www.hoovers.com
www.wikipedia.com
www.xe.com
Papleu, Bernard, and Healy. “Business Analysis & Valuation: Using Financial
Statements”. 3rd Edition. Thomson Southwestern, 2004.
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